Life insurance can help protect your loved ones, and help leave them financially secure after you're gone. Even better, life insurance can also help reduce the need to sort out tax issues on top of everything else.

What is inheritance tax?

When you die, your ‘estate’ (your property, your money and anything else you own as an ‘asset’) is added up and valued. If it comes to more than £325,000, anything above that amount may be subject to inheritance tax – currently 40%  . Tax laws and regulations can change at any time, of course, and this is based on what we know now. Bear in mind, tax treatment will depend on individual circumstances.

Seeing as how your life insurance counts as an asset, does that mean the amount your beneficiaries end up with could be 40% less than they were banking on?

Not necessarily.

Do you have to pay inheritance tax on life insurance?

It’s true that your life insurance – or the amount it pays out at least –can count as part of your estate when you die. If that’s the case and it pushes the total value of your estate over that £325,000 threshold then, yes, the 40% inheritance tax applies.

It's worth mentioning here that married couples and people in civil partnerships can combine their £325,000 thresholds, effectively doubling  what's called the 'nil-rate band'. This then means there's no inheritance to pay on estates valued up to £650,000.

Either way, it could mean more bad news for your loved ones at a time they'll have had enough bad news already.

However, thankfully, it's within your power to do something about it with just a little savvy financial planning. Specifically, by putting your life insurance in trust.

Life insurance in trust and inheritance tax

Putting – or ‘writing’ – your life insurance in trust is a simple way to keep it out of your estate.

In short, a trust is a legal arrangement that passes ownership of your policy to specific people you name (known as ‘trustees’). As it’s no longer legally yours it can’t be counted as part of your estate.

This means your loved ones get the full, tax-free benefit of your policy.

While setting up a trust is usually pretty straightforward, there are a few things to be aware of before pushing the button. It’s a good idea to make sure you’re happy with everything, so do your research and maybe talk to a solicitor or financial adviser too. Be aware that there are legal and tax consequences to setting up a trust and, once it's done, you can't simply change your mind and cancel it.

Using life insurance to pay inheritance tax

Of course, it’s perfectly possible your estate could be more than the £325,000 inheritance tax threshold, even with your life insurance in trust. So, can you use another life insurance policy to pay off the inevitable bill?

Yes. If it’s a whole-of-life insurance policy (sometimes known as life assurance), that is.

This is a type of life insurance that pays out whenever you die. It’s different to what’s called ‘term’ life insurance which only pays out if you die during a specified period.

The good news is there’s no reason why the proceeds from a whole-of-life policy can’t be used to pay off all or some of the likely inheritance tax bill.

Our over 50 life insurance is a whole-of-life policy, but it’s likely the amount of cover available to you wouldn’t be enough to pay off a potential inheritance tax bill. Instead, and to make sure you’re getting the cover you need, speak to a financial adviser. If you don't already have a financial adviser, you can find one at An adviser may charge for their services.

Either way, it’s good to know you have options. What’s most important is, with a little planning, at least you can be sure you'll be helping those you leave behind. And that’s all that matters.

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