BKL looks at how simple changes to one's financial affairs can save substantial amounts of Inheritance Tax
When a life insurance policy pays out, the default position is that the value forms part of the estate of the deceased. If Inheritance Tax (“IHT”) is chargeable on the estate, that means that up to 40% of the insurance pay-out goes to the Exchequer in tax.
However, this charge can almost always be avoided by writing the policy in trust. According to figures recently published by HMRC, IHT was paid in respect of nearly 8,000 life insurance policies in 2016/17, with the average IHT charge being £37,500. That’s some £300m effectively gifted to the Exchequer.
To be clear, writing a policy in trust in this way is not devious tax planning exploiting a loophole; it should be absolutely routine. Indeed, when the Office of Tax Simplification published their report on “Simplifying the design of Inheritance Tax” earlier this year (on which we reported here) it suggested that the default position should be changed so that such receipts would fall outside the charge to IHT.
Setting up the trust need not be complicated, and insurers often provide standard documentation. But as with all trusts it’s important to check that the arrangements meet your specific needs: something we can help with, of course. It’s not vital that the trust is set up at the same time that the policy is taken out (though that’s the obvious time to do it); it can be done subsequently. So, if you have an existing policy not written in trust, it’s not too late to do something about it now.
On a related point, it is worth recalling that where encashment of policies gives rise to an income tax charge, it will be more tax-efficient for trustees to appoint out policies to basic-rate beneficiaries and allow the beneficiaries to encash them, rather than cashing in the policies and distributing the cash.