IHT Planning

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Inheritance tax planning is done to help support your family to retain as much of your wealth as possible, when you pass away

I’d like to start out first of all with saying that full IHT planning should be done by a financial adviser. We are protection insurance specialists and life insurance is just one way to put measures in place to build your inheritance tax plans.

Our advisers are here to make sure that you get the right life insurance policy to protect your family.

It is always a good idea to speak with a financial adviser to determine your IHT planning, so that they can fully explore all options to protect your wealth in line with UK legislation and regulation. We are more than happy to point you in the right direction of a financial adviser that can do this.

What is Inheritance Tax?

IHT PlanningInheritance tax is paid in the UK when someone dies and their wealth is above certain levels.

For a single person the current level of assets that they can have is £325,000* before their family would need to pay inheritance tax. This is known as the nil rate band.

There is no inheritance tax between married couples, which means that when one partner dies, the other can inherit their assets without tax.

When this happens the partner that is alive will typically then gain the IHT allowance that their partner had. To try and make things as simple as possible most people generally say that a married couple has a combined allowance of £650,000*, before their estate would be taxed for inheritance tax upon their death.

An extra thing to know is that at the moment the UK government also allows you to increase your IHT level by what is known as the residence nil rate band. This currently sits at an additional £175,000*. There are specific eligibility criteria and limits to this which is why we suggest that you speak to a financial adviser to make sure you know exactly when your assets reach a level that Inheritance Tax will kick in.

When you know your total nil rate band you can then determine what Inheritance Tax that your next of kin may face. If your assets place you above the nil rate band you are allowed, then the IHT will be set at 40% of the value of your assets above the nil rate band. 

Let’s take a very basic example.

  • You establish that your nil rate band, the amount of your assets that won’t be subject to Inheritance Tax is £1,000,000.
  • Your assets add up to £1,800,000.
  • This means that IHT would be due on £800,000 of your estate.
  • The Inheritance Tax due on this would be £320,000.

But! There are many ways that a financial adviser can help support you and your family to plan for this.

One route is life insurance and this is where our protection adviser team can help you.

*Accurate at the time of January 2023

What insurances protect against Inheritance Tax?

There are a couple of ways to use life insurance to provide financial protection to cover Inheritance Tax.

  • Joint life second death whole of life insurance – This would be the usual way of setting up life insurance for IHT purposes, for a married couple. There is no IHT between a married couple so we wouldn’t want the policy to pay out after the first person dies. That would just add more value to the estate. Instead we specifically arrange a policy that pays our after both partners die, when the taxation will be triggered.
  • Single whole of life insurance – This is essentially a first death policy, as only one person is insured. You would typically use this insurance policy for someone that is single and leaving significant assets to their loved ones upon their death.

A key thing with both of these options for life insurance is that they are whole of life. They are designed to keep being active until you pass away. You might have other reasons for life insurance and may set those policies up for 20 years, 32 years, to age 70 or age 90. But for IHT purposes it’s most likely that whole of life insurance will be the most appropriate choice. 

It’s important not to arrange a joint life first death life insurance policy for Inheritance Tax planning. If you do this when the policy pays out if will pay to the surviving partner, added to the value of the estate and very likely making the IHT charge even bigger! 

There are alternatives to these options, that might be more suited to your needs and our advisers will discuss this with you.

When should I set up Life Insurance to cover my IHT needs?

This can be a tricky one to answer and there is not one rule fits all. With life insurance the younger you are, the cheaper the policy tends to be.

This is because statistics show that you are less likely to die unexpectedly, the younger you are. Also as we get older there is more chance of us developing health conditions that could make the premiums higher.

A lot of people can think that IHT planning is something that people do once they are in their 50s or older, and this is quite common. But it’s always worth having a think about the value of your assets every now and then to see if your estate falls into inheritance tax levels. Remember that property prices can shoot up quite quickly at times and you might find yourself within IHT limits without realising it.

What else do I need to know?

When you arrange a life insurance policy for IHT purposes you really want the policy to be placed into Trust. This is a legal document that means that when the life insurance pays out, the person that you want to receive it should get it far more quickly than if it’s not in Trust.

Probably the most important thing is that placing a life insurance policy into Trust, means that the payout from the insurance is not added to your estate. It’s essential to make sure that the life insurance is not added to the value of your estate, as it will mean that the Inheritance Tax charge will be even bigger than before.

With a Trust another essential part to watch for is a specific section that talks about retaining a terminal illness payout. With most UK life insurance policies they come with a clause that says that will pay out the money if you are diagnosed with 12 months left to live, so that your final time is as comfortable as possible financially. But, if you retain the terminal illness benefit it will again simply add to the estate and likely increase the Inheritance Tax charge. Every situation is individual but it’s quite likely that you will end up deciding not to retain the terminal illness benefit for yourself.

A life insurance policy is just one part of your Inheritance Tax planning and our advisers are here to support you in getting the life insurance that you need, alongside your long-term financial planning. 

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Review by Joseph and Vivian on 12th January 2023

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Dr Kathryn Knowles Phd

This page was written by Dr Kathryn Knowles Phd, an award-winning insurance adviser. To read more about Kathryn please see her bio here

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