Should you buy life insurance to avoid inheritance tax?
Some people are taking out life insurance to avoid inheritance tax bills in the future. Does the strategy make sense?
Could taking out life insurance help ease the worsening headache of inheritance tax (IHT) facing hundreds of thousands of families in the UK?
It could certainly help, say financial advisers, but that advice comes with a string of caveats – including a warning that you could end up paying out more in total premiums than the tax bill your family eventually ends up with.
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The government says very few families currently pay inheritance tax. That's true – in 2022-2023, the most recent tax year for which figures are available, fewer than 5% of deaths resulted in an inheritance-tax charge. Just 31,500 families faced a bill. But the numbers are set to rise quickly. The government's own projections suggest 10% of deaths will trigger an inheritance-tax liability by the 2029-2030 tax year; in other words, the number of families paying the tax is expected to more than double within just seven years. The official forecast is that inheritance tax receipts will rise to £14.5 billion by 2030-2031, 67% more than the Treasury expects to net in the current financial year.
This trend is well under way, says Shaun Moore, a tax and financial planning expert at wealth management firm Quilter. “IHT receipts for the 2025-2026 tax year reached £7.7 billion by the end of February, surpassing the 2023-2024 total of just under £7.5 billion with a month still to go,” he says. “IHT is certainly no longer a tax aimed only at the mega wealthy.”
There are a couple of reasons for this. First, the inheritance-tax threshold – the size of estate at which the tax becomes payable – has now been frozen since April 2009. The then Conservative government did introduce an additional “residence nil-rate band” in 2017, providing extra headroom against the value of the family home, but this has also been frozen at £175,000 ever since. The current government has said these freezes will remain in place until at least April 2031. This inevitably drags more people into the inheritance-tax net as household incomes and asset prices rise. The average value of a house, for example, has risen by more than 70% since April 2009.
In addition, the current government has added to the list of assets that count towards the value of your estate for inheritance tax purposes. Most significantly, from April 2027, any private pension savings you hold in defined-contribution schemes that are remaining at the time of your death will count towards your estate. Currently, most pension assets are exempt from inheritance tax.
The government is cutting some of the inheritance-tax reliefs available to families. Its plans include a cap on the 100% business or agricultural relief applied when bequeathing businesses or farms – from 6 April, you will only be able to pass on assets worth up £2.5 million free from tax per person; above this threshold, inheritance tax will apply at 50%. However a couple will still be able to pass on £5 million assets between them.
Taking out life insurance is becoming increasingly popular
Against this backdrop, many more families are rightly concerned they will one day face an inheritance-tax bill – and potentially a significant charge. That is prompting more families to plan ahead, with strategies such as taking out life insurance becoming increasingly popular. “As the screw is being turned on reliefs and exemptions, more families and their advisers are now reaching for the security of insuring against the IHT liability,” says Ian Dyall, head of estate planning at wealth-management firm Evelyn Partners.
It's a relatively simple concept. The idea is to work out how much inheritance tax your family is eventually likely to be liable for, and then to take out a life-insurance policy that will pay out enough to meet this bill. The most common – and simplest – type of life cover is term assurance, which pays out a fixed sum if you die during the term of the policy. However, this won't work for an inheritance-tax liability, since you can't be sure when you will die – if you live beyond the term of the policy, there won't be a pay-out. Instead, you typically need whole-of-life cover: as long as you continue to pay the premiums, these policies will pay out whenever you die.
It's also important that the policy is written inside a trust, a legal structure that ensures the proceeds of the insurance fall outside your estate. Otherwise, your family may face an additional inheritance-tax liability courtesy of the insurance pay-out. Most advisers and insurers will be able to help you structure the cover in this way, though there may be fees to pay for this service.
So far, so good, but there are issues with whole-of-life cover. First, it's important to understand what the cover will cost you – both today and in the future. Insurers calculate premiums according to factors such as your age, health and the size of the policy, and you may have to undergo a medical examination. The cover comes in two forms: reviewable, where the insurer has the right to increase your premiums over time, and guaranteed, where the premium you start with will never change. The latter tends to be more expensive at the outset, but gives you certainty that premiums will remain affordable for as long as you need the cover.
Whole-of-life premiums can be costly. Evelyn Partners says that for a healthy 50-year-old client seeking guaranteed cover of £1.4 million, the monthly premium would be roughly £1,250. Such a client would have to live until the age of 143 to have paid out more in premiums than the value of the insurance pay-out, but these are still sizeable monthly payments. Moreover, for older policyholders, the cost will be higher, particularly as health deteriorates, and some people may even struggle to secure cover. In some cases, total premiums paid will exceed the payout insured much sooner. For this reason, advisers often suggest taking out life insurance when you're younger – in your 50s or 60s, say.
“We'd look at whole-of-life insurance as a young person's game, comparatively,” says Tom Mullard, business director for tax services at Time Investments. “If you get guaranteed premiums, you know what you're paying, and you may even have investments generating returns from which you can pay the premiums so that you're not really seeing a decrease in your capital.” This does mean it's likely you'll be paying the premiums for longer, but the good news, adds Dyall, is that costs could fall. “Prices appear stable and, in some instances, are even coming down as providers compete for market share in the growing market.”
Is it better to save the money instead?
Still, some question whether whole-of-life insurance offers good value, particularly for policyholders in good health with many decades of life ahead of them. And once you've signed up for a policy, changing course by cancelling the cover will mean you've wasted the money spent so far. James Baxter, founder of financial planning firm Tideway Wealth, says it makes sense to think of a such policies as more like a savings plan than an insurance contract. You're effectively putting money aside each month so that eventually there is enough to pay a bill. “People should ensure that they understand these policies before signing as it could cost them more than they realise,” Baxter argues. “If a couple take out a policy aged 64 and one of them lives beyond 90, the effective return drops below risk-free rates, making the policy a less attractive savings vehicle.”
What he means is that by the time you get into your 90s, you'll have paid so much out in premiums that the sum your beneficiaries will get back represents a negligible – or even negative – return on the money. You'd have been better off putting the same amount of money into a risk-free bank or building society savings account each month. The counter to this argument is that funding an IHT liability through regular savings would not provide the certainty that many families want and need. You can't be sure you'll live long enough to put enough money by to settle the bill. Nevertheless, if you are going to go down the insurance route, it's vital to keep costs down. Shopping around will help –an independent broker can provide valuable help here – but it's also important not to think of insurance as a silver bullet for IHT planning.
Importantly, the more you can do to reduce your family's IHT liability, the less insurance you'll need to take out. That means ensuring you take full advantage of other IHT planning opportunities. “Life cover does not replace good planning – it supports it by dealing with the elements that planning cannot fully remove and by creating certainty,” adds Lyall. “The better the underlying planning, the smaller the amount of life cover required and the more manageable the premiums become.”
Make full use of gifts to reduce inheritance tax
Certainly, it's important to make full use of your gifting allowances to reduce the size of your estate. You can make gifts of up to £3,000 each year with no liability for tax, as well as many smaller gifts worth no more than £250 per person. Gifts of any size to charity are also exempt from tax and there are additional allowances for gifts for a family member's wedding or civil partnership. Gifts from income can also work well. If you can show that your regular monthly income exceeds what you need, you can give away as much of the excess as you like with no tax consequences.
In addition, consider making potentially exempt transfers – these are gifts that will fall out of the value of your estate for tax-planning purposes as long as you live for at least seven years after making them. You can even insure for the possibility of not living that long (see below).
Beyond gifting, professional advisers can help you with other IHT planning strategies, from the use of investment vehicles such as the enterprise investment scheme (EIS) to maximising business relief. “The bigger point is that planning has to start earlier,” adds Mullard. “It can be hard to justify thinking about these issues when you may have 40 years of life left ahead of you, but it will make it easier to come up with a holistic solution.”
Some nuances to consider
While whole-of-life cover may be ideal for insuring against your family's eventual inheritance tax (IHT) liability, term assurance could help you address a more immediate issue. Giving away large sums or valuable assets will reduce the value of your estate for IHT purposes – and therefore cut your family's bill – but these potentially exempt transfers only drop out of the IHT net seven years after you make them. In which case, a term assurance policy could provide cover against you dying sooner than expected and triggering a tax liability. The idea is to take out the insurance you need only for a set period – until your gift becomes fully exempt from IHT. This will usually be much more affordable than whole-of-life cover.
One nuance to consider here is whether your gift is eligible for taper relief, which could apply if you die with seven years of making it. After three years, many gifts qualify for this, with the rate of IHT payable falling from 32% at three to four years, to 8% at six to seven years. If so, you can take out a “decreasing term assurance” policy, which pays out a reducing amount over the term of the policy, and therefore costs less. Taper relief only applies if the total value of the gifts you make before you die exceeds the £325,000 tax-free IHT threshold.
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