Thousands paying needless inheritance tax through life policy blunder

Annual inheritance tax lability statistics for the tax year 2023/24 released by HM Revenue & Customs today revealed that:

• 4.72% of UK deaths resulted in an IHT charge, increasing by 0.10 percentage points from the tax year 2022/23

• The total number of UK deaths that resulted in an IHT charge was 30,400, a decrease of 1,100 (3.6%) compared to 2022/23

• IHT tax liabilities created were £7.03 billion. This was a rise of £0.33bn (5%) compared to the previous year

• Some 6,990 estates that paid IHT contained life insurance policies worth £852million

Ian Dyall, head of estate planning at wealth management firm Evelyn Partners, comments:

‘The annual increases in the proportion of deaths resulting in an IHT bill, and the total amount of IHT liabilities, are no surprise, not least as we have more recent data from HMRC on IHT payments showing that the trend is very much upwards as estates grow in value and exceed frozen nil rate bands by ever-larger amounts.

‘It is true that in recent months this trend has slowed – almost certainly because of the softening in property prices in London and the South East in the last few years – but that is unlikely to last long as we have yet to see the impact of the restrictions to agricultural property and business reliefs that came in in April. An even bigger driver of IHT liabilities will be the inclusion of unspent pension assets from next April.

‘These two IHT reforms have sparked growing interest in life insurance policies that can be taken out to cover an expected IHT bill, especially where estate planning options have been exhausted and the client is keen to protect their beneficiaries from the tax fallout. So the fact that nearly 7,000 tax-paying estates contain substantial life insurance payouts is quite staggering.

‘That’s because in many cases it’s totally unnecessary. By writing life policies into trust most families can ensure that the payout does not form part of the estate.

‘By not doing, it can be a real own goal, as a step that should make life easier for executors and administrators of estates, as well as saving on IHT (as the payouts during lifetime leave the estate), becomes one that can lead to probate delays and unnecessary IHT. 

‘Generally, all single-life policies and joint-life, second-death policies should be written in trust. Join- life, first-death policies usually won’t be as that would prevent both lives assured from benefitting and they are often set up to provide for the surviving spouse if the other dies. However, even these may be written in trust later on when they feel neither spouse needs the money from the policy.

‘Policies which contain critical illness as well as life cover payouts need special “split trusts”, effectively putting the life assurance element in trust but retaining the critical illness payments.

‘A study from one insurer has estimated that a minimum of 77.2 per cent of single life term policies are still not written in trust.[1] Today’s figures appear to confirm that serious failing and can be treated as a wake-up call for families to seek advice when purchasing life cover, especially as more and more households will be turning to these policies when pensions inflate their estates and potential tax bills.’

[1] https://www.actuarialpost.co.uk/downloads/cat_1/Swiss%20Re%20-%20Life%20Claims%20(balance%20of%20risk)%2011.24%201.pdf