Life insurance can bring you peace of mind, knowing your loved ones will be looked after when you’re no longer around.
But if your policy isn’t set up correctly, your family could face an unexpected tax charge.
If the value of your estate exceeds £325,000, it could be liable for Inheritance Tax
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”.
In 2025/26, the nil-rate band is £325,000. If the value of your assets is below this threshold, no IHT will be due. In addition, many estates can use the residence nil-rate band, which is £175,000 in 2025/26 if the main home is passed to children.
Combined, these thresholds allow you the potential to pass on up to £500,000 before your estate incurs an IHT charge. If you’re planning with your spouse or civil partner, you can also pass on unused allowances to them.
Importantly, the nil-rate band and residence nil-rate band are frozen until 2030, which may result in more families becoming liable for IHT.
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 ceases to exist if your estate is worth more than £2.35 million, or £2.7 million for couples.
IHT receipts are rising sharply – even before pensions come into focus for IHT in 2027 and any potential announcements in the 2025 Autumn Budget.
According to UK Investor Magazine, HMRC figures show that between April and September 2025, estates paid £100 million more in IHT than in the same period in 2024.
Meanwhile, the Office for Budget Responsibility expects the Treasury to collect a record £9.1 billion in IHT during the 2025/26 tax year.
If your life insurance policy isn’t structured correctly, a payout could tip your estate into Inheritance Tax territory
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.
According to a report from Insurance Business magazine, in the 2022/23 tax year, nearly 7,500 families in the UK paid inheritance tax (IHT) on life insurance policies.
HMRC data shows that 31,500 estates paid IHT – almost a quarter included life insurance, worth a combined £865 million. As a result, £346 million may have gone to HMRC unnecessarily.
Fortunately, there’s a simple step you can take to avoid this problem.
To ensure that any life insurance payout reaches your loved ones intact, put your policy “in trust”.
This legal arrangement appoints trustees to manage the policy on behalf of your beneficiaries until they are intended to receive the benefits.
Putting your life insurance policy in trust means it doesn’t count towards the value of your estate
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 make an IHT problem worse, as you’ll simply be increasing the size of your estate.
Protecting a life insurance payout from IHT is only one of the valuable benefits of placing your policy in trust. Ensuring your policy is correctly set up and written in trust could also:
- Give you greater control over the policy, which can be particularly useful if you aren’t married or in a civil partnership, as it can help to ensure that the money goes to your intended beneficiaries.
- Mean your loved ones may receive the payout much more quickly, as it bypasses probate – the legal process of sorting out an estate, which can be notoriously time-consuming.
There are several different types of trusts you could consider, and each comes with unique benefits and drawbacks.
As such, it’s important to speak to an expert before you put a life insurance policy in trust.
We can explain all your options and help you understand which might be most appropriate for you and your beneficiaries.
Get in touch
To find out more about how we can help ensure your life insurance policy is properly protected with a trust, please get in touch.
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.
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.
All information is correct at the time of writing and is subject to change in the future.
HM Revenue and Customs’ practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
The Financial Conduct Authority does not regulate estate planning, tax planning, or trusts.
Note that life insurance and financial protection 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.
Approved by The Openwork Partnership on 05/11/2025.