Inheritance tax avoidance – How life insurance can help

Inheritance tax is one of those things we truly love to hate. After a lifetime of saving and investing our hard earned money (which we paid tax on when we earned it), putting our loved ones in the position of losing a fair chunk of it again after our death seems nothing short of unfair. As a consequence, many of us are looking for ways to reduce or avoid this form of taxation. Could life insurance be the answer?

What is inheritance tax?

Inheritance tax is paid on any ‘estate’ which is worth over £325,000. Seeing as this often includes a house as well as possessions and savings, a large number of people are now over this threshold for tax. Currently, the rate of taxation on anything over this amount is 40 per cent, meaning your beneficiaries could be left with a big chunk to pay.

Relief on inheritance tax

One way in which inheritance tax can be relived to some degree is by passing wealth to a surviving spouse after death. This money would be given to your spouse tax free, and they would also inherit your tax free allowance, inflating the threshold to £650,000. However, even this can still leave a big hole in your estate when your spouse passes away; having an adequate life insurance policy of the right type could see additional relief being secured.

How a life insurance policy can help

Taking out a life insurance policy that you leave to your heirs is one way of getting money into their hands without the taxman taking a chunk. However, make sure you ask your provider to put your policy in trust, as this ring-fences it so that when you pass away, the money is paid straight to your beneficiaries.

Financial advice website Unbiased predicts that around £530million in unnecessary inheritance tax will be paid this year alone by people who failed to put their policy in trust. Putting your policy in trust will also mean the money will bypass probate, which means your loved ones will be able to get the finances faster, securing money to pay out for your funeral and other related costs that they may incur as a result of your death.

Money paid into a ‘whole of life’ policy such as this are usually viewed as ‘lifetime gifts’ by HMRC. This means that they are covered by one of the tax free exemptions applicable to you, such as the annual £3,000 exemption or the ‘gifts out of normal income’ exemption, and therefore non-taxable. This makes life insurance a great solution for legally avoiding paying too much inheritance tax, or leaving your loved ones with a big tax bill to pay after you pass away.

Buying life insurance

There are numerous providers who offer whole of life policies for people of all ages. It’s important to understand what you are buying into, and to make sure you get the best deal possible for the policy you need, so in some cases it can be good to talk to a financial advisor before settling on a policy.

Some providers, such as Vitality Life Insurance, offer excellent discounts and significant rewards for those who are in good health, which can make a whole of life policy more affordable over the long term. They also offer level premiums that don’t increase with age, letting you manage your budget more effectively over time.