Have you ever asked 'Can you have more than one life…
Yes or no, depending on the size of your estate and the approach you decide to take.
The proceeds from a life insurance pay out are not liable to either income or capital gains tax.
However, generally speaking, they do form part of the deceased’s estate, which depending on its size, could be subject to 40% inheritance tax.
An estate includes any property, savings and investments, possessions in your name and importantly for us in this article your life insurance policy.
However, any money used to cover personal debt and funeral costs are exempt from your estate.
Let’s delve into the detail to help inform you how your loved ones can reduce tax and make the most of your life insurance pay out…
The amount of inheritance tax (IHT) you pay varies depending on your personal circumstances and there are some key factors to consider.
The current threshold for having to pay 40% inheritance tax in the UK is £325,000, (or £650,000 for a couple - more on this below).
As a result, anything up to the value of £325,000 is tax-free.
If your property is worth £400,000, you have £50,000 in savings and £125,000 life cover, your estate is worth £575,000.
As a result, you would be subject to paying £100,000 IHT, (or 40% of £250,000).
But there is a way of reducing this tax bill significantly (£50,000), one which is free and available to most policyholders; writing your life insurance in trust.
Writing your policy in trust is free and is available on most policies arranged through Reassured.
It involves signing your life insurance policy over to another individual (trustee/s) to act on your behalf, similar to an executor of a will.
As a result of writing your life insurance in trust, the proceeds could avoid forming part of your legal estate and therefore this could avoid or minimise IHT.
There are other benefits too, most notably a faster pay out to your loved ones as they’ll not have to wait for probate to be granted.
If you have young children, you’re unlikely to want to give them access to substantial funds at a young age.
However, you can specify in the trust that you only want them to receive the funds when they reach adulthood.
In the simplified scenario above, if your life insurance was written in trust your IHT bill would be halved to £50,000.
This is because instead of your estate totally £575,000, it would be £450,000.
So, you would be taxed at 40% on £125,000, instead of 40% of £250,000.
Despite this saving, it’s estimated that only 6% of policyholders currently write their policy in trust.
These thresholds may seem high and you may not think IHT is anything for you to be concerned about, however, it’s important to think ahead.
Whilst the average price of a UK property is currently £287,506, considering how much house prices have increased over the last 20 years, it's not unfeasible that this value could rise to reach the IHT threshold in the near future.
Inheritance tax laws are regularly changed by the government.
In recent times there was a change which allows you to pass your property to your children (including adopted, children or foster children) or your grandchildren with an increased threshold of £500,000.
When you pass away, it’s possible (and common) to pass all your assets to your surviving spouse along with any unused tax-free allowance.
Their estate will then only be taxed after they pass away. However, because effectively both estates have been combined, the new IHT threshold is £650,000.
Who you make the trustee is very important as you’re effectively signing over the rights of the policy to them to carry out on your behalf.
Commonly a trustee is either a solicitor, a member of your family or a trusted long-term friend. It’s possible for a beneficiary to also be a trustee.
No, if you have life cover through your employer (sometimes called group life insurance or death in service) generally speaking you won’t have to pay tax, as it's classed as a benefit in kind.
There are policies available which fall into the life insurance category, but which are by default not subject to IHT.
Critical illness cover (CIC) will provide a pay out if you fall ill with a condition covered by the policy.
CIC policies pay out whilst the policyholder is still alive and are therefore not subject to IHT. They offer a good way of helping to protect your income if you become too ill to work.
Another less well-known option is family income benefit.
Instead of paying out a single lump sum, family income benefit pays your loved ones a regular monthly income for the remainder of the term and is thus not subject to IHT.
Is it always a good idea to write your life insurance in trust?
No, as with anything, there are always potential disadvantages.
The major disadvantage is that it can be hard to change certain trusts if your circumstances change.
For example, if you specify in your trust that you want the proceeds from your life insurance to go to your spouse, but you then divorce and remarry, it's likely you'll want your new spouse to benefit from your life cover but this change may be difficult to implement.
There are different types of trusts available; absolute, fixed and discretionary.
With a discretionary trust whilst they’re easier to change, your trustee/s have ultimate power on who gets what and when.
At Reassured, most policies come with the option of a discretionary trust to provide you with the utmost flexibility, however, we can’t stress enough the importance of appointing a trustee you can rely on.
At Reassured, we offer free expert support to help our customers write their life insurance in trust (if eligible).
We provide a simple, non-advisory run-through of the trust application process (flexible or discretionary trusts), without any complex insurance jargon.
This ensures you fully understand the process and are confident that your policy is dealt with as you wish after you're gone.
Simply contact the customer service team at Reassured today to make the most of your life insurance pay out.
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