How insurance could spare your family from an inheritance tax nightmare

This year, an estimated 40,000 families will be landed with an inheritance tax bill worth potentially hundreds of thousands of pounds.

One of the most unpleasant things about inheritance tax – charged on the part of an estate worth more than £325,000 – is that the individual whose estate incurs the 40pc levy will not be the one dealing with the final bill.

Instead, their family will have to calculate the tax owed and pay the liability within six months of the death.

However, it is possible to make life easier for your relatives by putting some money aside to pay the bill. You can do this by setting up an insurance policy that will pay out when you die.

Remember that any insurance policies you have will be included as part of your estate, meaning the final tax bill could end up even higher. This is why you must write the policy into a trust. Many insurance providers will do this free of charge. Here, Telegraph Money explains the different policies t and how to choose the best one for you.

HOW MUCH WILL A POLICY COST? A married couple, both aged 70, could expect to pay £330 a month for a whole of life policy paying out £200,000 on death, according to estimates by wealth manager Evelyn Partners. They would need to live more than 50 years before they paid more in premiums than the sum assured. The premiums will be higher if you have health issues and also the older you are. A couple, both 80, could expect to pay £630 per month.

Once you are above 80, it becomes more difficult to secure the terms and so there is likely to be a cap on how much the policy will pay out. These figures assume no commission so could be higher depending on the adviser used.

WHAT IS THE BEST POLICY?

Ian Dyall, of Evelyn Partners, said: “Care needs to be taken regarding which whole of life policy to use. They are not all equal and it is easy to get seduced by lower premium policies, which can be a costly mistake.”

He said: “The best policy for this purpose is a ‘guaranteed’ whole of life policy. These are more expensive at the outset than other alternatives, but the premiums are guaranteed not to increase, even if you live much longer than expected, which means that they should remain affordable until death.”

By comparison, with reviewable whole of life policies, the premiums are subject to change as you get older. Mr Dyall said he had seen clients with these policies whose premiums had grown eightfold.

INSURANCE POLICY FOR GIFTS Life insurance can also be used to cover the liability that arises when gifts are made within seven years of the person’s death.

Sean McCann, of NFU Mutual, said: “For those making non- exempt gifts who are concerned that they may die within seven years, it’s important to remember that outright gifts ‘eat’ the £325,000 tax free allowance first.

“The loss of part or all the allowance could be protected by taking out a seven-year ‘ temporary life insurance policy’. For outright gifts over the tax-free allowance, if you survive more than three years, the inheritance tax due tapers down.”