For some, even if they take many of the above steps to mitigate their liability, paying some IHT may be unavoidable.
For others, they may not wish to spend more, make gifts or invest into higher risk investments. Here, particularly for those still in reasonable health, life insurance can offer a means by which to offset a future IHT liability.
A life insurance policy can also be useful when it comes to obtaining probate. Where the policy has been written into a trust, the insurance pay-out is usually tax-free and will not form part of the estate, so can easily be used to pay IHT.
When you take out a whole-of-life policy, you pay regular premiums for the rest of your life in exchange for a lump sum payable on death. If the policy is taken out on a guaranteed basis, the premiums can be fixed for life at the outset.
A guaranteed whole-of-life policy can provide a ‘return’ of sorts for the beneficiaries. The exact return will always depend on how long you live. Those who die sooner than expected may pay very little in premiums for a very large pay-out. But even for those living a good innings, a virtually risk-free return in the region of 3-5% per annum might be achieved, which might suit more cautious investors. It is very rare for the premiums of guaranteed policies to exceed the eventual pay-out.
However, you need to commit to paying the premiums on a long-term basis; if you are unable to pay the premiums later in life, the policy will lapse and all earlier premiums will be lost. And be wary of ‘reviewable’ policies that are initially cheaper (but see very significant and often unaffordable premium increases later in life) and complicated policies with underlying investments.
Sarah, aged 55 and in good health for her age, has significant property assets and expects to have an unavoidable IHT liability of at least £1 million on death.
- Sarah takes out a guaranteed whole-of-life insurance policy and has it written into trust. For premiums of around £13,000 per year, the policy pays out £1 million on death.
- Sarah lives to age 90 and pays total premiums of £455,000 over 35 years. These payments reduce the value of the estate, saving IHT of up to £182,000.
- Because the policy is in trust, there is no IHT on the £1 million pay-out. This can be used to help pay the IHT liability, without the property assets needing to be sold.
- In effect, the whole-of-life policy provided a tax-free return of nearly 4% per year over 35 years.
- Sarah would have had to have lived to age 132 to pay more in premiums (in nominal terms) than the pay-out.
Term life insurance
As we discussed above, if you die in the seven years after making gifts (and those gifts exceeded your nil rate band), then your beneficiaries might need to pay IHT on the gifts. Your beneficiaries could hold part of the gifts in reserve to meet the potential IHT liability in case you die within seven years. Alternatively, you (or they) could arrange a seven year term life insurance policy on your life to cover the potential IHT liability, which can usually be done fairly cheaply.