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Life insurance policies and inheritance tax

If you take life insurance, inheritance tax may be due on the proceeds but setting it up can have a big difference on the amount of inheritance tax your estate will have to pay.

In this article
How can I cut down an inheritance tax bill? Life insurance policies in trust What are whole-of-life insurance policies?
What are decreasing-term policies? Get life insurance and protection advice

How can I cut down an inheritance tax bill?

If you take life insurance to make a one-off payment or regular income to your dependents when you pass away there is usually no income tax or capital gains tax to pay on the proceeds, but inheritance tax may be charged at 40%. 

However, it's possible to set up the policy within a trust so the proceeds aren't taxed as part of your estate. 

Looking to buy life insurance?

If you decide you need advice, make sure you consult an independent life insurance broker.

Which? Financial Services can refer you to an impartial, no-obligation third-party advice service to provide you with the best life insurance or mortgage insurance policy tailored to your individual needs. 

Find out more about the life insurance referral service at Which? Financial Services.

Life insurance policies in trust

Trusts are a legal structure which own assets that can be used by other people who do not technically own them. As such, the assets within them aren't taxed as part of your estate. 

With life insurance they can also speed up the pay out if you pass away. That's because you will be able to sidestep the probate process, which can add months to the claims process. 

Find out more in our guide to how to write life insurance in trust.

What are whole-of-life insurance policies?

If you think your estate will have to pay inheritance tax when you die, you could set up a whole-of-life insurance policy to cover the tax due, meaning that more is passed to your beneficiaries.

To ensure the proceeds of the life insurance policy are not included in your estate, though, it's vital that the policy be written in trust.

This is a very complicated area of estate planning and is best done with the help of a professional, such as a solicitor or independent financial adviser (IFA).

A whole-of-life policy has a double benefit – not only are the proceeds of the policy outside your estate for IHT purposes but the premium paid for the policy will also reduce the value of your estate while you're alive, further reducing your estate's future IHT bill.

Find out more in our guide to whole-of-life insurance explained.

What are decreasing-term policies?

An alternative to a whole-of-life policy is to give away part of your estate before you die. However, if you die within seven years of the gift, there could still be an IHT liability, as most gifts are deemed 'potentially exempt transfers' (PETs) for those seven years.

The good news is that the more time that passes, the less tax is due (as the tax due on a PET reduces, or is 'tapered', over the seven-year period).

This makes a seven-year decreasing-term policy a good – and, equally importantly, cheap – way to cover this potential IHT liability.

Find out more in our guide to term life insurance explained

Get life insurance and protection advice

Which? Financial Services Limited, part of the Which? Group, can refer you to our trusted partner to help you find insurance for your needs. Find out more at Which? Financial Services