Funding an inheritance tax bill

Inheritance tax is generally due by the end of the sixth month after death. While certain assets may qualify for payment by instalments, some or all of the tax may still need to be paid before probate is granted and the estate can be distributed. If wealth is tied up in property, investments or a business, the family may need to use their own money, borrow or sell assets to raise the funds.

A whole-of-life policy, usually placed in trust, could provide a separate lump sum to help meet the bill.

Whole-of-life cover is a type of life insurance designed to pay a lump sum whenever the insured person dies, provided the policy remains in force and its terms are met.

Unlike term assurance, which provides cover for a fixed number of years, whole-of-life cover has no set end date.

For couples, the policy may be arranged on a joint-life, second-death basis. This pays after both people have died, which is often when an inheritance tax liability arises because transfers between spouses or civil partners are generally exempt.

The level of cover is usually based on the estimated inheritance tax liability. The policyholder pays regular or, in some cases, single premiums to maintain the cover.

When the insured person dies, the trustees make a claim. If accepted, the insurer pays the lump sum to the trustees, who can use it in accordance with the trust terms. This could provide funds to help the executors pay the tax and progress the probate application without having to sell estate assets quickly.

The policy does not reduce the inheritance tax liability, it provides money that could help pay it.

Without a trust, a life insurance payment may form part of the estate. This could increase the value assessed for inheritance tax and the payment may not become available until probate has been obtained.

When an appropriate policy is written in trust:

• The proceeds are normally outside the estate for inheritance tax purposes.
• Payment can usually be made without waiting for probate.
• Funds may be available before the estate’s assets can be released.
• The family may be less likely to need to sell a home, business or investments to raise money.

Without a trust, the payment may form part of the estate, potentially increasing its value for inheritance tax and delaying access to the money.

The trustees must follow the trust terms. Legal advice may be needed when establishing and administering the arrangement.

Potential benefits

• Provide a known lump sum towards an expected tax bill.
• Give the family access to money while estate assets are unavailable.
• Reduce pressure to sell assets quickly.
• Help preserve more of the estate for the intended beneficiaries.
• Provide greater certainty as part of wider estate planning.

As an example, David and Sarah are married and have an estate worth £1.4m, including their home, savings and investments. They plan to leave everything to their children.

For this simplified example, both partners’ full nil rate bands and residence nil rate bands are available, providing combined allowances of £1m. This leaves £400,000 of taxable estate, 40 per cent of which leaves £160,000 of estimated inheritance tax.

Most of David and Sarah’s wealth is tied up in their home and investments, so their children may not have immediate access to £160,000. Some or all of the tax would normally need to be paid before probate could be granted and the estate assets distributed.

After receiving financial advice, David and Sarah arrange a joint-life, second-death whole-of-life policy providing £160,000 of cover. They place the policy in trust and appoint appropriate trustees.

When the second partner dies the trustees make a claim under the policy. If the claim is accepted, the £160,000 is paid to the trustees without normally becoming part of the estate. 

The trustees can use the proceeds in accordance with the trust terms, potentially making funds available to help the executors pay the inheritance tax bill. This could then help the executors pay the tax and progress probate without selling the home or investments simply to raise the funds.

The policy does not reduce the £160,000 tax liability, it provides money that could help meet it.

This fictional example is for illustration only. It assumes that the full allowances shown are available. Actual liabilities, allowances, premiums and tax treatment depend on individual circumstances and the rules in force at the time.

Whole-of-life cover is not suitable for everyone; it is recommended that professional financial guidance is obtained. Points to consider include:

• Premiums can be significant and may need to be maintained for life. If payments stop, the cover may end.
• Some policies have guaranteed premiums, while others may be reviewed and increased. With a reviewable policy, the premium could rise or the level of cover could reduce.
• A fixed payment may not keep pace with rising asset values or future changes to tax rules.
• Once a policy is placed in trust, the policyholder’s ability to change the beneficiaries or access the policy may be restricted.
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  Premiums paid into a trust may be treated as gifts for inheritance tax purposes. Available exemptions depend on individual circumstances.
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  The insurer must accept the claim, and the trustees must act under the trust terms before funds can be used.
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  Many protection policies have no cash-in value. Premiums may not be returned if the policy ends without a valid claim.

Tax rules, asset values and family circumstances can change. Regular reviews can help confirm that the estimated liability, cover, premiums, beneficiaries and trustees remain appropriate.

We can help you understand your potential inheritance tax liability and whether whole-of-life cover could form part of your wider estate plan.