How life cover could help clients deal with an Inheritance Tax liability

In the March 2021 Budget chancellor, Rishi Sunak, froze a number of tax breaks and allowances. One of those was the Inheritance Tax nil-rate band (NRB), which will now remain at the same level until 2026.

The NRB is the amount your clients could have in their estate before it becomes liable to Inheritance Tax (IHT), typically charged at 40%. For the next five years it will remain at £325,000 per person, plus an additional residence nil-rate band of £175,000 per person, which some property owners may also receive.

Couples could therefore each benefit from a NRB of up to £500,000.

This means your clients may have a NRB threshold of between £325,000 and £1 million, depending on their circumstances. If your client’s estate is worth more than this, they could reduce its value and any IHT liability through gifting. Our article about gifting to reduce IHT could help here.

That said, there might also be occasions when gifting is not appropriate.

When this happens, using life cover to make financial provisions may be an option, as it will typically mean money is available to settle any IHT liability after your client’s death. Read on to discover when life cover could be appropriate, and how a financial planner could help ensure it’s right for your client.

Gifting is typically used to deal with an IHT liability

The government allows a range of gifts to be made to reduce a potential IHT liability. This can be done by reducing the amount of assets above the NRB that would be liable to IHT, or reducing it down to within the threshold.

The latter would typically negate any IHT liability.

A key issue with these gifts can be that they are relatively small. For example, you can give a total of £3,000 to an individual (in the 2021/22 tax year), or it can be split between many people, but it must not exceed this amount.

As this is one of the larger amounts you can gift, it might mean clients with larger estates struggle to reduce their IHT significantly.

An option could be to use a potentially exempt transfer (PETs), which allows your client to gift unlimited amounts to any beneficiary they like. The only stipulation is that your client then has to then live for seven years for the gift to fall outside of their estate.

If they don’t, it typically falls under “taper relief”, which means IHT is due and charged on a sliding scale depending on how long they survive.

Gifting may not always be the right solution

If your client is elderly, or has a limited life expectancy, a PET may not be appropriate as they may not survive the seven years.

Another reason gifting may not be an appropriate way to deal with an IHT liability could be that your client wants to keep control of their money instead of giving it to others.

In both of these situations the estate will typically remain liable to IHT, which could significantly reduce the amount of money your client leaves to beneficiaries. This is because part of the inheritance will probably be used to settle the tax demand.

Life cover could provide a solution

If you have clients in either of these situations, they might want to consider life cover. While their estate would still be liable to an IHT liability, the payment made from the life protection on death could be used to settle all, or part, of the tax due.

As this means the tax is not settled using the assets left to beneficiaries, it effectively means your client could leave more money to loved ones.

Life cover could also decrease the time it takes for beneficiaries to receive their inheritance. This is because money from the estate cannot be released until the IHT liability is settled, which can take several months if assets need to be sold to raise the money needed.

As protection products typically pay out within weeks, your client’s beneficiaries could receive their inheritance more quickly.

The cover should typically be written in trust

If your client uses life protection to cover an IHT liability, it’s essential that it’s written into trust. If it is not, the payment on death could fall into your client’s estate, which is likely to increase its value and the potential IHT liability.

According to Money Age, in 2018/19 more than 6,000 estates paid IHT on life protection payments that could have been excluded if the cover had been written into a trust. The article adds that data by HM Revenue & Customs revealed that more than £280 million of IHT might have been paid unnecessarily on life policies.

Please remember though, the taxation of trusts is complicated. Therefore, care must be taken to ensure the life cover is written into the correct trust for your client’s needs, without generating a future tax headache.

This is why working with a financial planner can help you ensure a client’s trust is as tax-efficient as possible, and that the life cover is the most appropriate for them.

Get in touch

If you have clients who are writing a will, or have a substantial IHT issue that can’t be addressed by gifting, please get in touch. We’d be happy to discuss how life cover and trusts could help your client.

We can be contacted by email on hello@ardentuk.com or call us on 01904 655 330.

Please note

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

Please note, this article only deals with England and our understanding of English Law.

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