Life Insurance and Tax
Compare life insurance today to protect your loved ones tomorrow
Last updated: 02/02/2023 | Estimated Reading Time: 3 minutes
A life insurance policy can ease the financial burden on your family if you die by paying out either one lump sum or a set regular income should the worst happen. The last thing you want is for a significant proportion of this money to go to the taxman rather than to your loved ones and by writing your life insurance policy in trust, you can avoid this.
When you pass away, the value of your legal estate is calculated and, above a certain threshold, inheritance tax is charged on anything you leave to any beneficiaries.
The threshold is currently at £325,000, just over the value of the average Greater London property, and anything above this is taxed at 40%.
This can be quite a dramatic cut; reducing the pay-out your loved ones receive quite significantly but luckily, there are ways to avoid having to pay inheritance tax on your life insurance pay-out that we’ll explain now.
When you have a life insurance policy, either when you start it or during the policy term, you’ll have the option on doing what is known as writing the policy in trust at no extra cost.
What this means is that rather than the sum being paid out as part of your legal estate, it goes directly into a trust intended for a specific beneficiary or group of beneficiaries such as your children.
The trust will be looked after by a trustee, usually a relative or a solicitor, until such time as it is paid out to the beneficiary. If the beneficiary is your child, then you can set this at the date when they turn a certain age, say 18 or 21.
When you write a life insurance policy in trust, because the pay-out does not go to your legal estate, its value will not count towards the inheritance tax threshold and so the entire sum will go to who it is intended to go to.
Currently, reports suggest that only 6% of all customers write their life insurance policies in trust and while many have legitimate reasons for not doing so, there are still undoubtedly many who could be benefitting greatly if they did.
A further benefit of placing a life insurance policy into a trust is that the pay-out is often much quicker than it would otherwise be as the beneficiaries will not have to wait until probate is granted before receiving the money.
Probate is the legal process by which an executor is granted the permission the deal with the assets of the deceased and can often be a lengthy process, particularly if the deceased party has no will arranged.
Another way to save your family from having to sacrifice 40% of your assets to the tax man when you pass away is to dedicate a portion of your life insurance pay-out to paying off the inheritance tax bill.
This can be quite complex though given the calculations that have to be made post-mortem and so you should contact a life insurance specialist if you want to go down this route.