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        Updated: April 18, 2024

        Life Insurance and Inheritance Tax - A Quick Guide

        Read up on the rules around life insurance and inheritance tax and find out how to avoid being hit with unnecessary costs

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        We can help! We know everyone's circumstances are different, that's why we work with brokers who are experts in life insurance. Ask us a question and we'll get the best expert to help.

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        When you take out life insurance, it’s usually to ensure your family and loved ones will be financially secure in the event of your death.

        When it comes to planning how you’ll provide financial security for your dependents when you die, it helps to know what the UK tax rules are for life insurance.

        This guide is designed to help answer your questions about life insurance and inheritance tax and ways you can use life insurance when it comes to your estate and tax planning.

        If you’re short on time, use the links to jump ahead:

        What are the UK tax rules for life insurance?

        Usually, when someone receives a death benefit payment from a life insurance policy the money paid isn’t counted as taxable income, so the beneficiary shouldn’t be hit by a tax bill.

        However, it’s possible for a policyholder to delay payment following their death, and instruct the insurance company to hold the money for a set period of time after they have died. In cases like this the beneficiary may be required to pay tax on any interest generated during that time.

        Speak to a expert today

        Do you have to pay inheritance tax on life insurance?

        Although only a small percentage of estates in the UK incur inheritance tax (IHT) charges, it’s important to consider the potential of inheritance tax when you have life insurance.

        Inheritance tax is paid on any estate totalling more than £325,000. Any amount of money in an estate over this threshold is taxed at 40%, no matter what the income tax bracket of the beneficiary.

        If your life insurance policy pays out a lump sum or regular income to your beneficiary or beneficiaries, and the life insurance money takes your estate above the £325,000 IHT threshold, then the portion of your estate above the threshold will be liable to 40% tax.

        However, if your life insurance is paid directly to your spouse, civil partner or even a charity or community club of some kind, inheritance tax would not normally be charged, even if the amount in question exceeds the inheritance tax threshold of £325,000.

        It’s possible to use life insurance to help your beneficiaries cover any IHT liability. We discuss this subject in more detail below.

        How to avoid inheritance tax

        By writing your life insurance policy in trust, the lump sum paid out on your death doesn’t form part of your legal estate. This means that its value will not be included in your estate and avoids the likelihood of a high lump sum from your life insurance pushing your estate above the IHT threshold of £325,000.

        It also means that the entire amount paid out from your policy will go to your intended beneficiary or beneficiaries.

        Does life insurance form part of your estate after death?

        Unless you plan ahead and write your life insurance policy into a trust, the money from a life insurance payout will form part of your estate and may be liable to inheritance tax.

        If this happens, the executor of your estate will handle the life insurance payment and pass the money on to your beneficiaries once any IHT payment on your estate has been made. This process usually takes around 6 months, but in some cases can be longer.

        Is life insurance classed as an asset?

        Life insurance is classed as an asset when it is written in trust. By setting up life insurance inside a trust, you can set it aside as an asset to go to your chosen beneficiary or beneficiaries when you die.

        Using a trust for your life insurance policy can give you some control over what happens to the payout on your death.

        The life insurance asset is looked after or managed by trustees until the time that the beneficiary is to benefit. For example, a grandparent may wish to leave a life insurance payout to their grandchild but want them to get the money when they reach a certain age, often 18 or 21.

        In cases like this the lump sum payout would be managed until the intended beneficiary reaches the specified age, at which time the trustees would pay the money out.

        Setting up a trust like this is pretty straightforward. In many cases an insurer can arrange it for you. You can choose to put your life insurance policy in trust at any time, although it makes sense to do it early, and can easily be done when you take the policy out.

        The expert advisors we work with can help write your life insurance in trust. Make an enquiry and we’ll match you with an expert in writing life insurance policies in trust. The service we offer is free and there’s no obligation to act on the advice you receive.

        The benefits of putting life insurance into a trust

        There are a few advantages to writing your life insurance into a trust:

        1. You can control who gets the money from your life insurance by specifying the beneficiaries
        2. Often it speeds things up. Because a life insurance policy written in trust doesn’t form part of your estate, it avoids getting tangled up in lengthy probate proceedings so the money should be paid to your beneficiaries sooner
        3. It helps with planning your estate

        If you know your beneficiaries are going to be liable for inheritance tax when you die because your estate exceeds the IHT threshold of £325,000, you can use a whole of life insurance policy to cover the full amount of inheritance tax your estate will owe.

        By doing this you can protect your beneficiaries from having to struggle to find a way to pay the IHT bills. Your whole of life policy will guarantee a tax-free lump sum to cover the whole IHT liability.

        Speak to an expert

        If you’re interested in finding out how you could benefit from using life insurance to protect your estate from inheritance tax or want to ask if you should be taking precautions to protect your estate, talk to one of the experts we work with.

        Call 0808 189 0463 or make an enquiry and we’ll match you with an advisor experienced in advising customers on life insurance and inheritance tax planning. The service we offer is free and there’s absolutely no obligation.

        Ask A Quick Question

        We can help! We know everyone's circumstances are different, that's why we work with brokers who are experts in life insurance. Ask us a question and we'll get the best expert to help.

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        Pete Mugleston

        Pete Mugleston

        Mortgage Expert, MD

        About the author

        Pete, an expert in all things mortgages, cut his teeth right in the middle of the credit crunch. With plenty of people needing help and few mortgage providers lending, Pete found great success in going the extra mile to find mortgages for people whom many others considered lost causes. The experience he gained, coupled with his love of helping people reach their goals, led him to establish Online Mortgage Advisor, with one clear vision – to help as many customers as possible get the right advice, regardless of need or background.

        Pete’s presence in the industry as the ‘go-to’ for specialist finance continues to grow, and he is regularly cited in and writes for both local and national press, as well as trade publications, with a regular column in Mortgage Introducer and being the exclusive mortgage expert for LOVEMoney. Pete also writes for OMA of course!

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        FCA Disclaimer

        *Based on our research, the content contained in this article is accurate as of the most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information. The information on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms that are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs.

        Some types of buy to let mortgages are not regulated by the FCA. Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.