Life Insurance Inheritance Tax Guide 2024
Inheritance Tax (IHT) could potentially cost your family £1,000s on your life insurance payout when you die. But, there are some simple and legal ways to mitigate the risks of paying Inheritance Tax on life insurance claims. Most of us won’t need to worry about paying Inheritance Tax, but for those who do it can be useful to understand how this works.
Something as easy as writing your life insurance policy into a Trust can significantly reduce your Inheritance Tax liability. Life insurance Trusts help to ensure that your family, friends, or business, will receive as much financial benefit as possible from your life insurance policy.
In this guide, our team of insurance experts explains how Life Insurance Inheritance Tax works and all the most important things that you need to be aware of or think about.
60-Second Summary – Life Insurance Inheritance Tax Guide 2024
Life insurance Inheritance Tax (IHT) rules can seem complicated, especially if you have never needed to consider them before. This comprehensive guide explains exactly how life insurance Inheritance Tax works and how this could affect your payout.
- Inheritance Tax is charged at a 40% rate for amounts over £325,000, though assets left to spouses or civil partners can be tax-exempt. The threshold increases to £500,000 if your home is left to your ‘offspring’ (e.g. children or grandchildren).
- UK tax rules can change over time, and we aim to keep this guide up to date with this information being accurate for 2024. It may be worth consulting a financial advisor for advice about the current IHT rules.
- Writing life insurance into a Trust is a simple strategy to significantly reduce IHT bills, ensuring your loved ones receive maximum financial support.
- To avoid paying IHT on life insurance, placing the policy in a Trust is recommended. This also enables faster policy payouts by removing the policy from your estate.
- If you need simple advice about how life insurance and Inheritance Tax works, you should speak to a financial advisor or an experienced life insurance expert.
What is Inheritance Tax?
Many people find Inheritance Tax (IHT) confusing, as it isn’t a topic which comes up often. If you aren’t a financial expert, it’s likely that you may never have needed to fully understand what Inheritance Tax is.
Inheritance Tax is where the UK government taxes the estate of a person who has recently died, which includes their property, money and possessions. Your estate will only be taxed if the amount it is worth is above the Inheritance Tax threshold (£325,000 as of February 2024).
This video from HM Revenue & Customs (HMRC) explains what Inheritance Tax is in simple terms and how it works. It also notes how important it is to be aware of any money the deceased owed, which would need to be paid out of their estate.
What is the UK Inheritance Tax rate?
Currently, you will be charged Inheritance Tax at a rate of 40% for anything over the threshold amount (£325,000). This means that if your estate is worth £400,000, the Inheritance Tax bill would be 40% of the £75,000 above £325,000.
In the above situation, your loved ones would have to pay £30,000 in Inheritance Tax, which is an extremely expensive tax bill. In some cases, this tax bill could be reduced to 36% of anything above £325,000 if you leave 10% or more of your estate to charity.
Note: Any reduction in Inheritance Tax would apply to the ‘net’ value of your estate, which is the total value minus any outstanding debts.
Who pays Inheritance Tax?
If the person who died had a Will then it will usually be the executor of the Will that would arrange to pay any Inheritance Tax bills related to the estate. Another option is to use the government’s Direct Payment Scheme (DPS) to arrange for the tax to be paid directly from the deceased’s bank account. You can view the Gov.uk guide to Paying Inheritance Tax for all the ways in which Inheritance Tax bills can be paid.
Once Inheritance Tax and any other debts have been paid, the remaining money and assets will then be given to the person’s chosen beneficiaries or next of kin.
Citizen’s Advice has created a comprehensive guide which explains how to deal with the property of someone that has died, which includes information about Wills and probate.
How much is my estate worth?
Having an idea of how much your estate is worth can help you to estimate if your loved ones are likely to be taxed when they inherit it. The simplest way to work out how much your estate is worth is by:
- Listing all of your assets and how much they are worth (e.g. an estate agent valuation for your home)
- Add these figures together to come up with an overall sum
- Deduct any debts that may need to be repaid in the event of your death
You can use this overall figure to try and work out the amount of inheritance tax that your family members or other beneficiaries will need to pay.
The Gov.uk website contains a full guide on how to value an estate for Inheritance Tax purposes which can be found here: Gov.uk – How to value an estate for Inheritance Tax and report its value
How does Inheritance Tax (IHT) work?
Financial journalist Martin Lewis is often viewed as an expert in areas like life insurance and taxes. In early 2024, he published 5 important facts that many people don’t realise about how Inheritance Tax works.
- Married people will avoid Inheritance Tax: Anything you leave to your spouse or civil partner won’t be subject to Inheritance Tax. This doesn’t apply to someone you are cohabiting with but not married to or in a civil partnership, even if you have children or a mortgage together.
- You only pay Inheritance Tax on large amounts: The first £325,000 left as inheritance won’t be liable for Inheritance Tax. You won’t normally need to worry about Inheritance Tax if your overall assets (e.g. house, car, savings) are worth less than £325,000 total.
- If you leave your home to your children, you can leave £500,000 tax–free*: If you leave your home (primary residence) to your ‘offspring’, the Inheritance Tax threshold rises to £500,000. The definition of offspring here includes biological children, adopted, foster or stepchildren or your grandchildren.
- You can leave your spouse or civil partner any of your unused Inheritance Tax allowance: If you don’t use the Inheritance Tax allowance mentioned above by leaving your home to your children, your surviving spouse or civil partner can use your allowance. This means that if they intend to leave everything to your children/grandchildren, their tax-free allowance doubles from £500,000 to £1million.
- If you are eligible to pay Inheritance Tax, you may be able to reduce the amount: Gifts from your annual income won’t be taxable and if you gift anything else it won’t be liable for Inheritance Tax if you die at least 7 or more years later. Gifts to charity can also help reduce inheritance tax liability.
Note: *This threshold increase to £500,000 will not occur if your overall estate is worth more than £2million.
This recent video from MoneySavingExpert.com shows Martin Lewis explaining more about his 5 ‘need-to-knows’ for Inheritance Tax rules. You can also see a full breakdown of Martin Lewis’ views and advice about life insurance in our Martin Lewis Life Insurance Guide.
Not everyone will need to pay Inheritance Tax when someone close to them has died. HMRC figures have shown that only 1 in 20 estates in the UK will need to pay Inheritance Tax.
UK tax rules can change over time and everyone’s circumstances will be different. If you are concerned about potential Inheritance Tax liability, it’s worth speaking to a solicitor or financial advisor for more information about the current rules.
Do you pay Inheritance Tax on life insurance?
The rules can often seem unclear around life insurance and Inheritance Tax with many people searching phrases like ‘Does life insurance get Inheritance Taxed?’ online.
There are a few factors that will affect whether you would pay Inheritance Tax on your life insurance policy such as:
- How much your estate is worth: Your estate includes all your financial assets such as money, property, investments, stocks etc.
- If your life insurance is included in your estate: Unless you specifically separate your life insurance from your estate, if your level of cover is high it could push your estate over the Inheritance Tax threshold.
The amount of life insurance coverage that each person has will vary and anyone with a larger cover amount (e.g. £500,000, £1million) is more likely to be eligible for Inheritance Taxes.
How can I avoid paying Inheritance Tax on life insurance?
The simplest way to prevent your life insurance benefit from being taxed is by writing your policy into Trust. This is an easy (and usually free) process that is offered by most UK insurance providers. Insurance brokers will generally ask if you would like a Trust when they are helping you to set up your policy. This is a common arrangement in the UK and comprehensive information around Trusts and taxes can be found on the Gov.uk website here: Gov.uk – Trusts and Taxes
A Trust also gives you greater control over your life insurance policy, by allowing you to specify exactly who benefits from your policy pay-out. Many people see this as a free alternative to a Will, but a Trust will be specific to your life insurance policy only.
Another benefit to putting your life insurance policy in a Trust is that the money will normally be paid out quicker. This is because the policy pay-out will be free from drawn-out legal processes like probate which usually occur when processing an estate after death.
Is life insurance part of an estate UK?
Once your life insurance is in Trust, it is legally owned by the policy trustees, and you won’t be the legal owner anymore. Because of this, any money within the Trust won’t be classed as being part of your overall estate so it usually isn’t taxable.
While this is very useful, you won’t be able to take your life insurance out of a Trust once it is in one. You should consider this carefully and make sure you are completely happy with this arrangement before making any decisions.
Note: Not all policies written in Trust will be exempt from taxes (e.g. under income tax), depending on the situation and the type of life insurance. You should check with a solicitor or financial advisor if you’re not sure where you stand with your policy.
What is exempt from Inheritance Tax?
‘Gifted’ assets can be exempt from Inheritance Tax if they were given more than 7 years before the person died. For any gifts given within 7 years of your death, your loved ones may need to pay tax based on factors like:
- Their relationship with you (e.g. family or friend)
- The overall value of the gift
- When they gave the gift to you
There are various items that HMRC would classify as a ‘gift’ item including money, stocks and shares, property or any personal items (e.g. expensive jewellery or antiques).
You can gift items to your spouse or civil partner which would be exempt from Inheritance Tax regardless of when the gift was given. The only exception to this is if you aren’t legally married or your spouse or civil partner is not a permanent UK resident.
The best approach if you are unsure whether a gift will be liable for Inheritance Tax is to speak to a solicitor or financial advisor for advice.
Note: Anything left to your loved ones in your Will isn’t counted as a gift, as it is a part of your estate.
Is life insurance a way to leave an inheritance?
Many people in the UK view life insurance as the best and easiest way to leave a cash inheritance for their families. A life insurance policy will pay out a cash lump sum in the event of your death which can be used to cover key expenses such as funeral bills or mortgage repayments.
Certain types of life insurance policies (e.g. whole of life, over 50s cover) are viewed as ways to leave a tax-free cash gift for your loved ones. As these policies will normally pay out smaller amounts, they are less likely to push your estate over the Inheritance Tax threshold.
Can you use life insurance to pay Inheritance Tax?
Some people may find that their overall estate will be worth more than £325,000 and so will be liable for Inheritance Tax. This can happen even if you have split your life insurance from your estate by writing your policy into a Trust.
In this situation, it is possible that your loved ones could use some or all the money paid out from your life insurance to cover these costs. However, Inheritance Taxes can often cost tens of thousands of pounds, so you should make sure that you have enough cover in place if you think this is likely to happen.
An experienced life insurance advisor will be able to assess how much life insurance you need, based on factors like your annual income and regular outgoing expenses. You can also quickly check how much coverage you might need to protect your home or family by using our helpful Life Insurance Calculator.
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Frequently asked questions about Inheritance Tax
How much money can you inherit without paying Inheritance Tax?
At the moment, up to £325,000 can be left in an estate before Inheritance Tax would be charged. However, this doesn’t just apply to money (e.g. savings or investments), as an estate will include other assets too such as property.
If you owned a property worth £250,000, you could only leave up to £75,000 in cash, stocks, bonds or other assets before your loved ones would be taxed.
Can I just gift £100K to my son?
You can give cash gifts to your loved ones, but these gifts would only be exempt from Inheritance Tax if they were given more than 7 years before you died.
With an amount as large as £100,000, there may be other tax implications involved so it would be best to get some advice from a qualified financial advisor.
Do I have to pay Inheritance Tax on my parents’ house?
The property will fall under the category of being a part of your parent’s estate if they die. You may need to pay Inheritance Tax, depending on how much the property is worth and how much the rest of the estate is worth.
Inheritance Tax rules do mean that the threshold is higher if the property is left to your children or grandchildren, so it is possible you may not need to pay any Inheritance Tax at all.
Need life insurance advice?
If you need advice about your life insurance and how to leave an inheritance for the people you love most, you can speak to our top-rated life insurance experts. There are several forms of life insurance to choose from including:
- Level-term life insurance (family protection): This policy is designed to pay out a set cash lump sum to support your loved ones in the event of your death.
- Decreasing term life insurance (mortgage protection): This policy is designed to cover your remaining mortgage balance, so it can be fully repaid if you die.
- Whole life insurance: This is a form of guaranteed life insurance which will cover you indefinitely and is guaranteed to pay out to your loved ones. People often use these policies specifically for inheritance tax planning.
- Family income benefit: This is a lower-cost form of life insurance that pays out smaller regular cash payments rather than one large cash lump sum.
- Business life insurance: You can buy life insurance that is designed to protect your business which includes policies like relevant life insurance and key person insurance.
We’re on hand to offer advice and support for every aspect of life insurance and what type of coverage might work best for you. To speak to our expert insurance advisors for free and friendly guidance, you can call 0800 009 6559 or CLICK HERE.