While only one in four families will pay inheritance tax, for those who do fall into this category it can be a source of frustration and worry but certain life insurance policies can offer some relief.
The Inheritance Tax Burden
If you leave your estate to your wife, husband or registered civil partner there is no inheritance tax payable, but if you leave your estate to your children, grandchildren or other loved ones then inheritance tax is a consideration.
Currently, inheritance tax is only paid on an estate that exceeds £325,000, anything above this is subject to a substantial 40% tax rate. If you are married or in a civil partnership, then both partners can pass on their nil rate band of £325,000 to their heirs so the total tax-free allowance increases to £650,000. If you pass your main residence to children or grandchildren there is additional tax relief of £175,000 (providing your estate is valued below £2 million) and again this is doubled if both you and your partner die and pass on to your direct descendants. Even taking this into account, high property values in the UK mean that many more families are landed with inheritance tax bills that run into thousands.
If you have paid tax throughout your life and carefully set aside savings and capital in the hope of passing it on to your children, it can feel unfair to burden them with a hefty inheritance tax payment. Inheritance tax is due before probate is completed and within six months of your death. The only exception to this is assets tied up in property (HMRC accept that money held in property takes time to release) but there is still an obligation to pay a proportion on account. If inheritance tax is not paid within the six-month time frame, HMRC starts charging interest, even if you have agreed to spread payments.
Inheritance Tax Mitigation
Some people feel the best option open to them is to give the bulk of their assets to their children before they die but you must survive for at least 7 years, otherwise, gifts will still be subject to inheritance tax.
Other sensible options to help reduce the inheritance tax burden are:
How Can a Life Insurance Policy help with Inheritance Tax?
Life insurance policies offer an alternative option to reduce your inheritance tax burden. There are several forms of life policy and they all offer something slightly different with of course variations in cost.
Term Life Policies
These policies offer one of the best economic solutions for most families. Term Life policies will cover death or critical illness for a limited period. People often take out a term life policy when they are in their twenties or thirties to cover mortgage costs and income for their family and a policy might typically last for around 25/30 years. There is no limit to the number of term policies you can run simultaneously. Each policy is completely distinct so if a policy expires as you reach 65 years old you can take a new term life policy for a further ten, fifteen, twenty years that potentially covers inheritance tax costs for your children. If you ensure that this money is held in a discretionary trust on your death it will not be included as part of your estate. Holding the money in trust for your heirs also means that the lump sum can be paid before probate is completed.
One of the difficulties of taking out a term life policy when you are older is that you may have more complicated pre-existing medical conditions but Castleacre works with an excellent panel of specialist insurers who offer cover on a case-by-case basis, even with pre-existing medical conditions.
Whole of Life Policies
Whole of life policies guarantee that when you die your surviving heirs will receive a set lump sum, although it is important to arrange as a discretionary trust. Naturally enough this is an expensive option because the insurers are committed to paying out the full sum whether you die at 60 or 106. It is a high risk for insurers because there is a chance that you could die soon after taking a policy out and the insurer would have to honour the agreement with very few premium payments.
These policies, though expensive, can be cost-effective for your heirs because inheritance tax will be covered by the policy on your death (providing your assets do not increase dramatically in value) and the total payments can also reduce the overall value of your estate, indirectly reducing IHT.
If your estate is subject to inheritance tax and you decide to gift a large proportion of your assets during your lifetime your heirs will have to pay inheritance tax if you die within seven years of the gift. In these circumstances, you might choose a shorter-term life policy that covers the inheritance tax liability during those seven years.
If you would like any advice on finding suitable life insurance for your circumstances contact our life insurance advisor Ali Adham who can investigate the best options available to you and your family.
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