There are a variety of options that may be available to help you reduce your Inheritance Tax liability. These include Agriculture Property and Business Property Relief (where available), lifetime giving and charitable donations.
However, an often-overlooked solution is life assurance to fund Inheritance Tax. This provides a cash lump sum on death to pay off the Inheritance Tax immediately, allowing the estate to remain intact rather than be sold off in whole or in part to raise funds to discharge the liability.
Ring-fencing life assurance
Life insurance for the purposes of discharging an Inheritance Tax liability must be set up and managed properly. This means the policy must be set up by way of a trust so that the payout goes straight to the beneficiaries. Failure to do so can result in the payout falling within the deceased’s taxable estate (with the potential to be charged at a 40% tax rate) and therefore potentially increasing the Inheritance Tax liability. This can also mean the payout gets caught in the probate process and is unavailable to the family for many months or even years.
The appropriate level of life assurance
The amount of life insurance required will usually reflect the estimated Inheritance Tax liability which is normally 40% of their estate above the nil-rate band and residence nil-rate band if the family home is left to children or grandchildren.
A married couple with an estate worth up to £2 million can pass on £1 million of estate assets without incurring an Inheritance Tax charge. However, the residence nil-rate band is tapered for estates over £2 million at the rate of £1 for every £2 that the estate is worth over £2 million.
Whole life assurance versus term life insurance
Whole of life insurance (also known as life assurance) protects your whole life and pays out on death, whenever that is. Life assurance policies may be on a single or joint life basis, and there are circumstances whereby the policy and the premium can reduce to reflect assets given to children. Life insurance (or term insurance) is fixed for a set period and only payouts if you die within that period.
Term insurance may be more suitable if the concern is an Inheritance Tax liability arising in respect of assets given during a donor’s lifetime. In certain circumstances, if you live for seven years after giving a gift, no tax is owed on it (unless it’s part of a trust). But if the donor dies within the seven years, Inheritance Tax is due according to when the gift was made.
Gifts given within three years before your death are taxed at a rate of 40%, while gifts given between three and seven years before your death are taxed on a sliding scale called “taper relief.” A term policy may therefore be an effective way of safeguarding against any potential liability arising in these circumstances.
The cost of the premium
All of the above begs the question as to how much life assurance designed to cover an Inheritance Tax liability is going to cost. This will be determined by a number of factors including the amount of cover required and the age of the policyholder. The younger you are when you take out the policy, the cheaper it will be, and other factors that will be taken into account include health and lifestyle. You may also require the services of a specialist broker to ensure the best deal as well as finding a policy that meets the unique demands of your circumstances.
There are online premium cost calculators although they should always be approached with caution. As a rough starting point and at the time of writing, whole life cover for someone who is 60 and wishes to cover £100,000 would be in the region of £185 / month or £2,220 p.a. This then in turn needs to be considered in the context of someone who at 60, has an estimated remaining life expectancy of 20 years. And as always, the use of a life assurance policy to mitigate Inheritance Tax should be part of a well-considered and regularly reviewed tax strategy.
If you would like to discuss the idea of a life assurance to fund Inheritance Tax or an Inheritance Tax and tax planning issue, please get in touch.