When they buy their first home, most people take out a life insurance policy to cover their mortgage in the event of their death; in fact many people falsely think this is something they have to do, but not many people take into account the bigger picture by building further financial plans around their death.

 

As we’ve covered in the other blogs in this series, inheritance tax is payable at a standard rate of 40 per cent above any assets a person has higher than the current threshold of £325,000. When you consider the average value of a home in the UK right now is £232,710, it means a great many people are likely to have some inheritance tax to pay. As well as property, their estate also includes vehicles, business interests, and cash placed in savings and bank accounts. Even payouts due from life insurance policies must be taken into account.

 

The benefits of life insurance

If a person takes out assurance against their own life, although the policy can’t pay out until they die, there is a specific inheritance tax provision that means the proceeds are treated as part of their estate. They’ll therefore be subject to inheritance tax.

 

However, it is often the case that life insurance is taken out purposefully to cover inheritance tax liability. One common policy type selected for this reason is a ‘whole of life’ policy, which pays out on death, and has a double benefit. Proceeds from this type of policy are classed as outside your estate when you die and are therefore not subject to inheritance tax. In addition, premiums paid throughout the lifetime of the policy actually reduce the value of your estate, meaning your inheritance tax bill is reduced.

 

Another policy type used to insure against inheritance tax is a reducing or decreasing term policy, which covers the liability payable by the recipient of a gift if the donor dies within seven years following the receipt of that gift. Essentially, this policy type is used if you plan to give away part of your estate before you die – as we talked about in our previous blog in this series, the gift would be a potentially exempt transfer under inheritance tax rules, so there would be no inheritance tax on that gift if you survived for a seven year period following the transaction. And if you don’t survive that long, less tax would still be due the more time that passes, so a reducing-term life insurance policy can be a cost-effective option.

 

What about trusts?

Putting your assets into trust is one of the most effective ways to financially plan for your death because trusts offer far more flexibility than outright gifts.

 

A trust is created when the person placing their assets into a trust, also known as a settlor, transfers these assets to trustees, who hold them in trust for their intended beneficiaries.

 

There can be a number of reasons to set up a trust, not always connected to tax. For example, life interest trusts are often used to protect family assets, as they give the asset owner more control over where their assets end up. They may have children from more than one marriage, so a life interest trust can help ensure each child benefits equally and no favour is shown to the children of the current civil partner or spouse.

 

Discretionary trusts are most useful where the settlor isn’t sure what proportions of their assets to leave to certain individuals. In this case, a ‘letter of wishes’ is often left by the settlor that explains their priorities to the trustees, who then make the decisions as to who will receive what.

 

Trusts are not always exempt from inheritance tax, and there will be significant legal and professional costs in both establishing and running a trust, so while they can be a great option, they’re not for everyone.

 

Inheritance tax may be due when assets are transferred or settled into a trust or out of it, when it is closed for example, at the 10th anniversary of its creation, and when the beneficiary of certain types of trust (principally those set up before 22 March 2006 or created on a death) dies.

 

 

Planning for death is not a simple matter, with lots to consider you may never have thought of. It’s well worth having a discussion with a suitably qualified accountant or solicitor, who can advise you as to whether inheritance tax planning through trusts and/or life insurance is necessary for you and your specific circumstances.

 

Contact us today on 01642 244090, at info@chuhanandsingh.co.uk or via our website at chuhanandsingh.co.uk/contact to set up an appointment to talk through your potential needs.