Will the taxman take your life insurance pay out?

Nobody knows what is around the corner, but at least with a suitable insurance policy in place, we can feel certain that our loved ones would be provided for if we were no longer there to take care of them ourselves.

But how certain can we be, if the taxman can help himself to up to 40% of the pay-out from our insurance?

At Continuum we are looking at the cost of inheritance tax, or IHT and at ways to avoid the taxman being the biggest beneficiary of your life insurance.

How does the taxman profit from your death?

Life insurance policies are designed to pay out a cash lump sum to your loved ones on your death.  You can ensure they will have a cash lump sum to pay off the mortgage or provide a regular income.

However, the cash lump sums paid are treated like most other assets and form part of your taxable estate for inheritance tax purposes.

IHT is levied on our estates – the property, money and possessions we leave behind. Although we don’t pay it ourselves, it can take a big chunk out of what our loved ones receive. IHT is charged at 40% on all your assets above the threshold of £325,000 (as per tax year 2020/2021).

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Not sure what IHT might mean to you? Call us for a free initial discussion.

If we don’t take the right precautions while we are alive, the taxman can help himself to 40% of everything we leave, including the life insurance payout that our loved ones (rules may vary for spouse or Civil Partner) could be depending on.

There are some concessions for the family home, which means your dependants may be able to keep a roof over their head. But if you have a pension and some investments, it can be very easy to have an estate worth considerably more than £325,000 – which may mean that a large slice of the insurance money you arranged for your loved ones could potentially go straight into the coffers of the treasury.


It’s a matter of Trust

However, you can take steps to avoid IHT liabilities simply by writing your insurance policy into trust.

A trust can keep your insurance out of the hands of the taxman and ensure that it goes to those who deserve it. The entire payment can be passed to your chosen beneficiaries without fear of taxation.

A trust is an arrangement that allows you to legally gift the cash lump sum payable from your life insurance policy to your chosen beneficiaries. Once you have done so, the policy is looked after by a third party, known as the trustees, chosen by you.  By placing the insurance policy into trust, you effectively give ownership of it to the trustees, which means it can no longer be part of your own taxable assets.

The taxman will simply not be able to touch them. Writing a life insurance policy into trust typically requires filling out a simple form and it may be as simple as ticking the right box when you apply.

In fact, many insurance policies will automatically be written into trust, meaning the money paid out to your family should you die is ring fenced and falls outside of your estate for tax purposes.

If your policy does not automatically pay out into a trust arrangement, you can write it into trust by contacting your insurer who should be able to do it for you.

In fact, a whole of life insurance policy can provide a simple way to deal with your IHT liabilities. Take out a policy in trust, and your executors can use the proceeds to pay off the IHT bill. Obviously, the younger you are when you take out the policy, the less it will cost, so to make economic sense, you will need to do this early in life.

At Continuum we have answers to the questions of inheritance tax. A call to us could help you find the best way to ensure your loved ones get the benefit of your wealth, not the taxman.

We can help you check that your life insurance is protected by a trust – and if it is not, we can help make suitable arrangements to get it protected.

When you have questions about IHT or life insurance, getting expert advice, and getting it as soon as possible will help. Simply call us at Continuum for the advice you need.

The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable Protection products or investment strategy, you should seek independent financial advice before embarking on any course of action.

The Financial Conduct Authority does not regulate Taxation or trust advice or will writing.


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