You are probably aware of the advantages that having life insurance can bring – not least peace of mind for your family that if the worst happened, they may receive a payout that can help them cover immediate costs.
What you may not know, though, is that for most people, simply having life insurance isn’t always the most advantageous option. Writing the cover into trust is often a more prudent way to go.
Keep reading to learn why putting your life cover into trust could be a good move ahead of key legislation changes set to come into force in April 2027, plus how a financial planner could help.
Pensions will be included in Inheritance Tax calculations from April 2027
At the moment, your pension(s) are exempt from IHT. If you passed away tomorrow, you could pass down an unlimited amount of wealth to your children and grandchildren, provided it was held within a pension.
As announced in the 2024 Autumn Budget by Chancellor Rachel Reeves, unused pension benefits are set to be caught in the IHT net from the 2027/28 tax year onwards.
Remember, the IHT nil-rate bands are not rising in line with inflation, nor are they being adjusted to accommodate pensions. The nil-rate band stands at £325,000 and the residence nil-rate band, available to those passing their main home down to a direct descendant, is £175,000. They are both frozen until 2031.
So, the maximum an individual can pass down IHT-free (not including trusts or other mitigation tactics) is £500,000, and this will remain unchanged from April 2027.
Take a moment to think about:
- The approximate value of your estate, without your pensions
- How this measures against the value of your estate when pensions are included.
This simple exercise could enlighten you to just how much of a difference this new rule might make to you and families like yours. Perhaps your estate will be brought above the IHT threshold where it previously sat under it, or your wealth could have already been exposed to IHT and will now be even more so.
Putting life insurance in trust could protect it from Inheritance Tax
If you pass away and your family makes a successful life insurance claim, they may receive a lump sum from your insurer, which could help them cover key costs, including:
- Funeral expenses
- Housing costs
- Your IHT bill, or a portion of it.
According to the latest available data from the Association for British Insurers (ABI), the average payout for term life insurance was £79,703, while the average payout for whole of life cover was £7,408. In either case, your family might appreciate a financial boost to alleviate stress during a time of grief.
That said, if your estate surpasses the IHT nil-rate bands, your life insurance payout could be included for tax purposes. IHT is charged at a standard rate of 40%, meaning a large chunk of your insurance money could end up in the hands of HMRC, not your family.
Insurance Business reports that in the 2022/23 tax year, nearly 7,500 families paid around £346 million in IHT on life insurance payouts alone. What’s more, these additional IHT charges were somewhat unnecessary because writing the cover into trust could have removed the payouts from those estates for IHT purposes.
Indeed, writing your life cover into trust means that the cover is entirely removed from your estate for IHT purposes.
There are two key advantages to doing so:
- Your family could benefit from receiving the whole amount from your insurer, rather than losing a portion of it to tax.
- It could also help them avoid waiting for a long probate period before receiving your payout – as the funds are outside your estate, the trustee may be able to distribute them sooner.
Now, keep in mind the upcoming changes to pensions and IHT. While putting life cover in trust has long been a good move for many families, it may now be even more important to proactively mitigate the IHT levied on your estate in future.
Your financial planner can help you protect your wealth ahead of legislative changes
There are several strategies you could look into ahead of the pensions and IHT legislative changes coming up in April 2027. A few months ago, we published an article about the positives of lifetime gifting if you want to reduce the value of your estate, and it may be helpful to revisit it now, or speak to your financial planner to learn more.
Of course, taking out life insurance (if you do not have it already) and placing it in trust could be a simple yet effective way to keep wealth safe from IHT. As you read earlier, your trustee could make a claim on your behalf and pass the wealth directly to your family without the involvement of HMRC.
While this won’t solve any problems created by the inclusion of pensions, it could save your family from paying unnecessary IHT in the event of your passing away.
Get in touch
To discuss the upcoming change to IHT rules, life insurance, or any other financial matter, email admin@stonegatewealth.co.uk or call us on 01785 876222.
Please note
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning or tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
Note that life insurance and financial protection plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.
Cover is subject to terms and conditions and may have exclusions.
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