How life insurance can ease death tax bills
Families paid nearly £5bn inheritance tax last year. Life insurance may help you fight back, reports Sam Brodbeck
As the taxman’s haul from inheritance tax reaches record highs, families are using increasingly inventive ways to limit death duties. High house prices and buoyant stock markets pushed the amount that HMRC collected from inheritance tax to £4.8bn last year. Politicians’ decision to freeze the £325,000 per person tax-free allowance since 2009, although a new allowance for family homes has recently been introduced, also contributed to the rise.
One way to guard against leaving your family with a large tax bill is to buy a life insurance policy, a tactic increasingly used by financial advisers when they help wealthy clients to cut their liability.
These policies can either be “term”, typically covering a period of five or 10 years, or “whole of life”, meaning that they are active until death.
In exchange for a monthly premium, calculated by insurers according to your age and health, a lump sum is paid on your death. Premiums are either variable or guaranteed. In the former case premiums can be raised by insurers and can quickly become unaffordable, leaving policyholders thousands of pounds poorer and without any cover at all.
Guaranteed premiums start at a higher rate but give certainty over future costs. “These policies are great as long as you keep paying the premiums,” said Ed Fairey of Ed Fairey Associates, a financial advice firm.
“As long as the policy is ‘ in trust’ the sum assured will go to the beneficiaries and will not be subject to inheritance tax. In effect it’s a longterm savings policy for the kids. It also provides cash to pay any inheritance tax rather than force a sale of the family home or any other asset.”
Any inheritance tax due has to be paid before a “grant of probate” can be issued and inheritors of an estate receive their share. In some cases families are forced to cover the bills out of their own pockets or take out short-term loans to pay the tax.
Term or whole of life plans set up to pay into a trust do not form part of the deceased’s estate and are immediately available to the named beneficiaries of the trust, avoiding these difficulties.
Let’s imagine that after the conventional and new “family home” allowances were used an estate was left with £500,000 liable to inheritance tax. That would mean a tax bill of £200,000. It would cost a 65-year-old male non-smoker £432 a month to ensure that a £200,000 lump sum was paid on his death. This premium, from AIG, is the best rate on the market, according to Fairey Associates.
If he died 20 years later (as is suggested by official mortality statistics) he would have paid out £103,745, just over half of the assured sum, in premiums.
Prices rocket to insure older people because the chance of them dying soon is far greater. A non-smoking 80-year-old man would have to pay AIG £1,085 a month for the same cover. At that rate he would have to live until the age of 96 to have paid more than £200,000 in premiums.
As unused inheritance tax allowances can be passed between spouses, advisers recommend that couples buy a joint whole of life policy arranged to pay out only on the second death.
For a non-smoking couple where the man is 70 and the woman 65, the best rate to ensure that £200,000 is paid out is £330 a month from Zurich.
As with all long-term financial planning there is the risk that your circumstances or the political landscape change. Your assets may grow more quickly than you expected, meaning that the eventual payout is insufficient to meet the tax bill.
On the other hand, the Government could make the inheritance tax allowance more generous. That could mean the lump sum far exceeds the eventual tax bill and using income to pay monthly premiums might seem foolish in retrospect. While the £325,000 inheritance tax free allowance has remained unchanged
BEST GUARANTEED LIFE INSURANCE RATES Policyholder
Aged 65 (non-smoker) Aged 65 (smoker) Aged 80 (non-smoker) Aged 80 (smoker) Couple, aged 65 & 60 Couple, aged 70 & 65 for eight years, a new additional allowance came into effect in April this year.
The “main residence nil-rate band” gives each person £100,000 on top of the usual allowance in respect of their home. By 2020-21 it will rise to £175,000, meaning a couple will be able to pass on £1m tax free.
In Charles Dickens’s novel family members battle for an old man’s inheritance