Can my Loved Ones Use Life Insurance to Pay for Inheritance Tax?

Wednesday, February 17, 2010

In the past there was a serious attempt by the government to prohibit the use of certain trusts for the purpose of paying inheritance tax bills. It seems as quite a logical thing for individuals to do but equally, it is not surprising that the Government isn’t keen on this. Due to the lobbying of many legal business institutions, as well as public consent, there has been some backtracking with regards to these laws.

This being said, there are changes in these laws that remain very complicated and even Inheritance Tax (IHT) specialists struggle much of the time to come to terms with what they actually mean. These new rules were developed and drafted to be applicable to accumulation and maintenance trusts, interest-in possession and life insurance policies written in trust. To follow is a more detailed explanation on how these IHT rules affect life insurance policies.

The way the rules lie now, IHT must be paid at a rate of 40 percent for anything over £285,000. Now, there are different ways of getting around this but by far the most popular is to take out a whole life insurance policy that pays out a sum equal to this amount. The one catch here is that the policy must be made out in trust to ensure that the payable amount falls outside of the confines of your estate. Even this, however, is not as simple as it might seem. For instance, one needs to be careful what kind of trust is used. The easiest form of trust to use is a bare trust. This will ensure that the payment is guaranteed to your beneficiary upon death. At this time it can be used for any tax purposes.

A far more complex way of writing a policy is to set it up as an interest-in-possession trust. This will make the policy pay out to a series of trustees that will pay out when and how they deem fit. In this case the policy amount is subject to as much as a 6 percent tax, however, this is still better than the possible 40 percent due in IHT. Obviously depending on the policy and for how long the policy is written, it can be quite expensive but likely an acceptable expense when one takes into account the fate of loved ones.


Gerry McEvoy