While it’s hard to contemplate your potential demise, doing so could help you understand the potential consequences of your passing.
Along with the practical considerations, like how you wish your assets to be distributed, there are financial ramifications to think about, such as whether your family will have enough to maintain their lifestyle if you’re no longer around.
When it comes to providing for your family, having the right financial protection in place can be invaluable. Knowing that your loved ones will be looked after, even if the worst were to happen, can take a huge weight off your mind.
Read more: Protect what matters – why insurance plays a crucial role in your financial plan
The problem is, even if you have life insurance in place, the potential payout could be subject to Inheritance Tax (IHT) when you pass away. If this happened, your family may struggle to cover their costs.
Fortunately, you’re able to protect your life insurance policy from IHT. Read on to learn out how.
Financial protection could provide support to your loved ones if you pass away unexpectedly
Building financial security for your family can be hugely rewarding. It can be very satisfying to see your loved ones flourish, secure in the knowledge that they don’t need to worry about money.
This may be especially true if you have children, as you know that you are giving them the best opportunities in life when they are ready to fly the nest.
Life insurance could help protect your family – indeed, it could prove invaluable. This is particularly relevant if you’re the primary breadwinner.
In the event that tragedy struck, not only would your loved ones be emotionally devastated but they might also struggle financially.
Yet such a payout could become subject to IHT, meaning your family may receive a reduced amount and struggle to afford to meet all their costs of living.
With this in mind, here’s a quick recap on the rules surrounding IHT.
IHT is typically charged at 40% on assets above a certain threshold
Depending on the value of your assets, when you pass away your loved ones may have to pay IHT. Typically, the standard rate of IHT is 40%.
You will only be taxed on wealth that exceeds the tax-free threshold called the “nil-rate band” (NRB). In the 2024/25 tax year, the nil-rate band is £325,000.
If you plan to leave your main residence to your children or grandchildren, they can also benefit from the “residence nil-rate band”, which raises the threshold by up by a further £175,000. Combined, this means that you can pass on a total of up to £500,000 when you die.
Both nil-rate bands have been frozen until 2028.
It’s also worth noting that, if the value of your estate exceeds £2 million, the residence nil-rate band is tapered by £1 for every £2 above the £2 million limit. In effect, this means that the additional allowance effectively ceases to exist if your estate is worth more than £2.35 million, or £2.7 million for couples.
If you think you may have an IHT liability when you die, life insurance may be one way to tackle the problem. Yet, the payout from a life insurance policy could count as part of your estate, and may end up being subject to IHT.
Fortunately, there’s a simple step you can take to avoid this problem.
Putting your life insurance policy in trust means it doesn’t count towards the value of your estate
One of the best ways to ensure that any life insurance payout reaches your loved ones intact is to put your policy “in trust”.
This is a legal arrangement that appoints trustees to look after the policy on behalf of your beneficiaries until such a time as they are intended to benefit.
Crucially, writing your life insurance policy in trust means that, rather than forming part of your legal estate, any payout goes directly to your beneficiaries. And no IHT will be due on the proceeds.
If you don’t write the policy in trust, you could just make an IHT problem worse as you’ll simply be increasing the size of your estate!
There are other potential benefits to writing your life insurance policy in trust, too:
- It can give you greater control over the policy – this can be particularly beneficial if you aren’t married or in a civil partnership, as it can help to ensure that the money goes to your intended beneficiaries.
- Your loved ones will likely receive the payout much more quickly – this is because it bypasses probate, the legal process of sorting out an estate.
Since there are different rules surrounding trusts, it’s important to speak to an expert before you put a life insurance policy in trust.
If you want to protect your life insurance policy from IHT with a trust, you may want to seek professional advice first. We can help to make the process faster and easier, giving you peace of mind that your family won’t have to struggle financially after you pass away.
Get in touch
If you’d like to find out whether putting life insurance in trust could be a suitable strategy for you, please get in touch. We can also help you devise an estate plan to ensure the smooth and tax-efficient transfer of wealth.
Email contactme@kbafinancial.com or call us on 01942 889 883.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.
Note that life insurance plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.
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