Life insurance policies generally pay out a premium in the event of the policyholder’s death. However, recently published figures from HMRC suggest that many of them are falling into an easily-avoided tax trap.
The idea behind a life insurance policy is simple – the individual agrees to pay premiums for a fixed period of time. If they die within that time, the insurance company will pay a lump sum. The tax trap occurs because the policyholder’s death means that the estate immediately holds a valuable asset, i.e., the amount of the lump sum, which is a chargeable asset for inheritance tax (IHT) purposes. HMRC’s recently published figures have been analysed by industry experts, and it is reported that £280 million of IHT paid in 2018/19 (the most recent year that detailed statistics are available for) related to insurance policies. But this charge is entirely avoidable.
To avoid the trap, the policyholder simply needs to ensure the policy is written into trust. This means that the asset belongs to the trustees, not to the death estate. The lump sum is not counted when working out the IHT due. As an added bonus, because the lump sum is not part of the estate, it can be paid out to the specified beneficiaries immediately, i.e., without needing to wait for probate to be granted. Part of the problem is that it is very easy to buy policies online, with no input from a qualified advisor. While there may be an option to write the policy into trust, the significance of choosing the option may not be clear to the buyer.
Existing policy holders should contact their insurers to ask whether their policy is written into trust and, if not, review the benefits of settling it into trust.