Inheritance tax insurance is a simple solution to a complex problem. This article explains how inheritance tax insurance works, and why you might want to consider it if you have an inheritance tax liability.

Key points:

  • What is inheritance tax insurance?
  • Why consider inheritance tax insurance?
  • Types of cover
  • Important considerations

What is inheritance tax insurance?

Inheritance tax insurance is a type of whole of life insurance cover. You can set up an insurance policy to pay out a lump sum on your death. The idea is that with this whole of life insurance policy you will be able to fund the inheritance tax you owe rather than avoid paying inheritance tax.

You pay for the insurance while you are alive and it will provide your family with the lump sum to pay the inheritance tax on your death.

An example

John and Linda are both in their early 70s. They have a combined estate for tax purposes of £1,000,000 made up of their house, savings and investments.  They know that when either of them die, their estate will pass to the survivor. However, on second death their children will need to pay inheritance tax as follows.

Value of estate on second death = £1,000,000
Inheritance tax threshold on second death = £650,000
Taxable estate = £350,000
Inheritance tax payable at 40% = £140,000

John and Linda could make gifts of £350,000 to their children and hope to survive 7 years from the date of these gifts. However, they prefer to retain control over their assets, as they need the income from them and may need to fund future care costs.

Instead, they set up a whole of life inheritance tax insurance policy designed to pay the £140,000 tax liability on second death.

Why consider inheritance tax insurance

  • A simple solution
    Inheritance tax insurance is a simple solution to a complex problem. There are many ways to avoid paying inheritance tax. See our article on 7 strategies to avoid inheritance tax. The advantage of inheritance tax insurance is that it is straightforward. You can simply set up a policy with the knowledge that on your death the proceeds will pass to your family to be used towards your inheritance tax bill. You do not avoid tax with inheritance tax insurance – you provide the means to pay it.
  • Retain control over your assets
    The second major advantage of inheritance tax insurance is the ability to retain full control over your assets while you are still alive. In our experience most people put off doing something about their inheritance tax liability. This is usually because the solutions presented are too complicated, or because they worry that they might need the assets in the future. The advantage of inheritance tax insurance is that you do not need complex trusts or to give away assets. Instead you simply fund for the liability in the future.

Types of inheritance tax insurance

Inheritance tax insurance is whole of life insurance. This is a type of life assurance which guarantees to pay out a lump sum with no end date on it. therefore, if you maintain the policy payments you can be sure that it will pay out.

There are 3 main types of inheritance tax insurance:

  • Maximum cover
    This is the cheapest form of cover in the short term. Usually what happens is that for the first 10 years of the plan your payments are kept low. Your payments will partly fund insurance and partly fund an investment portion of the policy. After a set period your policy will be reviewed and the payments reassessed based on the performance of the investment element. Since the initial payments have been set to be lower cost, it is likely that the costs will dramatically increase in the future.
  • Balanced cover
    This works much like maximum cover, except that the initial costs are set at a more realistic long-term level. The policy is still dependent on the investment performance but it is much less likely that significant increases will occur in the future.
  • Guaranteed cover
    This tends to be the most secure form of cover, but also the most expensive. Guaranteed cover sets the cost at the outset and this will not change in the future. Therefore, if you want to be sure that your inheritance tax insurance costs do not change, then this is the best option.

Costs of inheritance tax insurance

As you can imagine inheritance tax insurance can be expensive, especially when significant liabilities need to be insured. However, if you are in a married couple (or civil partnership), you can make the policy cheaper by setting up on a joint life second death basis. The basic rule of thumb is that the older you are the more expensive it will be. Costs will also increase the greater the cover required.

Important considerations

  • Reviewing cover
    You need to regularly review your cover. It is common for assets to grow at a faster rate than the inheritance tax threshold. What this means is that over time you inheritance tax liability could be getting bigger. Therefore, you need to build in regular reviews of your inheritance tax insurance so that you are sure that your cover is sufficient to cover your liability. Of course, any insurance is better than none.
  • Age
    Inheritance tax insurance is cheaper the younger you are when you set up the policy. It is generally not available after age 80 at entry, although some policies can have up to age 85 at entry.
  • Health
    If you have underlying health conditions this can make the policy more expensive or even mean that you are refused cover.
  • Trusts
    Your inheritance tax insurance policy should be written into trust. If this is not done, your insurance will add to your estate on death and you will pay even more inheritance tax. By writing the policy in trust you will avoid inheritance tax on the proceeds and also allow your family to receive the money quicker. Your insurance company will provide you with free trust wording when you set up the policy.
  • First death or second death
    In a married couple you would typically set up your inheritance tax insurance to pay out on second death since transfers between spouses on first death are usually tax free. However, you should take care with the set-up of your policy since inheritance tax can be a complex area.

What next?

If you have a liability to inheritance tax and would like to consider insurance we can help you to analyse your situation. We can help you to work out whether inheritance tax insurance is the right option for you, or whether other methods could be useful.

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Dan Woodruff

Certified Financial Planner & Chartered Wealth Manager at Woodruff Financial Planning
Financial Planning helps you to navigate and anticipate significant life changes. I want to help you to ensure your money is managed wisely to give you the financial security that will fund the future and lifestyle that is important to you.

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