This article was first published on February 15.
Insurance policies designed to cover inheritance tax (IHT) bills are being snapped up amid fears that the government is about to make it harder to pass on your wealth to your family.
Brokers say that demand for insurance to cover potential IHT liabilities has doubled since the chancellor revealed that pensions will be included as part of an estate for IHT purposes from April 2027.
Wes McCranor from Sphere Assured, a brokerage in London, said: “It is all I have worked on since October. The budget definitely spurred people into making gifts and sorting out their estates sooner rather than later, and with that insurance to cover any liability.”
Life insurance has long been a popular way to ensure your family has a lump sum when you die that can be used to settle any tax debts with HM Revenue & Customs. But brokers have also seen an increase in clients taking out insurance policies that last seven years, and which could cover potential tax on larger one-off gifts. Here’s how it works.
When do you pay IHT?
IHT is charged on the value of someone’s estate when they die. The first £325,000 is IHT-free — £500,000 if the estate is worth less than £2 million and includes a main residence left to a direct descendant. Anything left to a spouse or civil partner is IHT-free and couples can also inherit one another’s tax-free allowances to leave a combined total of £1 million between them. Gifts made at least seven years before you die are not counted as part of your estate for the purposes of IHT, which is typically charged at 40 per cent.
The bill usually has to be settled with HMRC within six months from the end of the month of death and beneficiaries of an estate can struggle to pay it without liquidating investments or selling the family home. But any property held solely in the name of the deceased cannot be sold without a grant of probate — and IHT usually has to be paid before probate has been granted.
This leaves families in a Catch-22 situation. They could take out a loan to pay the tax while waiting for probate, or agree a payment plan with HMRC, but both will incur interest. The taxman’s annual rate of interest is set at the Bank of England’s base rate plus 2.5 percentage points, rising to 4 percentage points in April.
• Best over-50s life insurance
How can insurance help?
There are three types of insurance that can cover IHT liability: whole of life policies; “gift inter vivos” policies, covering specific gifts rather than someone’s entire estate; and term insurance covering set periods of 10 or 20 years, or until the age of 90.
Whole of life policies are the most popular and these can be bought as a single-life plan, for those who are single or not married, or a joint-life second-death plan, preferred by couples, which pays out only when the second person dies.
Anyone with a whole of life policy will need to pay a monthly or annual premium until they die, otherwise the policy will not pay out at the end. Some 28,975 whole of life policies were taken out in 2023 — up 4 per cent from the 27,807 in 2022, according to the insurer Swiss Re.
A gift inter vivos policy lasts for seven years, and if you die before seven years is up the policy payout will help to cover the IHT bill. The payout drops in line with the tax tapering which reduces the IHT on the gift if you die between three and seven years after a gift is made.
McCranor said: “We have also seen a big take-up in joint-life second-death policies covering a term of ten or twenty years or longer. This is good for people who are looking at their tax liabilities for their wider estate, and not just a one-off gift.”
How much will it cost?
Policyholders can choose between a reviewable policy (where premiums are reassessed by your insurer after a certain period of time) or a guaranteed policy (where premiums are permanently fixed). It can be tempting to choose a reviewable policy, which is initially much cheaper than a guaranteed policy, but premiums can shoot up as you get older and soon become unaffordable.
The Times Your Money Matters column has had many letters from readers caught out with whole of life policies that ended up costing them a lot more than the cover turned out to be worth.
If you find the premiums on a whole of life policy become too high, you can cut costs by reducing the payout you will get, but you run the risk of not having enough to settle an IHT bill.
The cheapest reviewable single life policy for £200,000 worth of cover for a 50-year-old is £37.65 a month with Royal London, according to the broker Cura Insurance. This shoots up to £214.89 for a 70-year-old looking for the same cover. A guaranteed single-life policy for the same level of cover for a 50-year-old costs £212.33 a month.
McCranor said: “The most important thing to remember when taking out a life insurance policy is that it is held in trust, otherwise the payout will be counted as part of your estate when you die and potentially liable to IHT. Once the policy has paid out, the trustees will give this money to the beneficiaries, who will use it to pay HMRC.”
If you are looking for a gift inter vivos policy, the cheapest for a 70-year-old seeking £50,000 worth of cover (which would be enough to pay 40 per cent tax on a gift worth £125,000) is £29.37 a month with LV.
• A guide to life insurance and how it works
Why not just give it away?
The changes announced in October’s budget triggered a surge in families giving wealth away to reduce the size of their estate before pensions are brought into the tax net. Some 41 per cent of families who are changing their financial plans intend to make more gifts before 2027, according to a survey of 2,000 adults by Canada Life.
Chris Etherington from the accountancy firm RSM said: “The potential IHT on a gift typically follows the gift itself, which means it is the person who received the gift that can be liable to pay a tax bill if the donor dies within seven years.
“This is prompting queries around specialist life insurance, particularly when larger gifts are being made.”
Mike Strutt from the insurance broker Risk Assured, based in London, said: “Very often people use a blend of a whole of life policy, to cover the family home and cash left in the estate, and a shorter-term policy for any big gifts. The crucial thing to remember is that insurance for IHT is not tax avoidance — it is putting a plan in place to provide enough liquidity for your family to pay any tax owed after your death.”
