How a Life Insurance Policy Can Help Reduce Inheritance Tax

Inheritance Tax is often seen as a tax on success, but for many families, it comes as an unexpected bill at the worst possible time. If the value of your estate exceeds the IHT threshold, your loved ones could face a tax charge of 40 percent on everything above that limit.

The good news? A properly structured life insurance policy can help mitigate this liability, protect your legacy and give your family greater financial certainty.

Here is how it works.

What Is Inheritance Tax?

Inheritance Tax is charged on the value of your estate when you pass away. This includes:

• Property
• Savings and investments
• Business assets
• Pensions not in trust
• Life insurance policies not written in trust

The standard nil rate band is currently £325,000, and married couples may also benefit from the residence nil rate band if passing on a main home to direct descendants.

Any value above those allowances is typically taxed at 40 percent.

How Life Insurance Can Help

Rather than trying to reduce the value of your estate directly, a life insurance policy can be used to offset the tax due.

The policy pays out a lump sum on death
This can be used by your executors or beneficiaries to cover the IHT bill, avoiding the need to sell assets like property or shares under pressure.

It provides liquidity at the right time
Probate can take months, and HMRC expects IHT to be paid within six months of death. Life insurance offers fast access to cash so your family does not need to borrow or liquidate assets early.

It preserves your estate’s value
Instead of shrinking your estate through lifetime gifting or complex structures, insurance provides an external solution that allows you to maintain control over your wealth.

Why It Must Be Placed in Trust

If your life insurance is not written in trust, the payout will form part of your estate — which means it could increase your IHT bill.

By placing the policy in a discretionary trust, you achieve two things:

• The payout sits outside your estate for tax purposes
• The trustees can access and distribute the funds quickly and flexibly after death

This simple legal step ensures the money goes where it is needed — and is not delayed or taxed unnecessarily.

Types of Policies Commonly Used

◆ Whole of life insurance
Provides cover for your entire lifetime with a guaranteed payout. Ideal for IHT planning because the timing of the tax bill is certain.

◆ Term insurance
Provides cover for a fixed number of years. Less common for IHT mitigation but may be useful for temporary needs, such as covering the tax on a large lifetime gift during the seven year taper period.

◆ Joint life second death
A popular structure for couples. Pays out when the second person passes away, which is usually when the IHT liability arises.

Considerations When Using Insurance for IHT

Cost versus benefit
Premiums can be significant, especially if you are older or have health issues. But they may still be cost effective compared to the size of the tax bill.

Underwriting
Health and lifestyle will affect premiums. It is important to apply well before cover is needed, especially if you plan to use whole of life insurance.

Regular reviews
Your estate value and tax thresholds may change over time. It is important to review the policy regularly to ensure it still meets your goals.

Use alongside other strategies
Life insurance is just one tool. It can work alongside gifting, trusts, business relief and pension planning to create a complete IHT strategy.

Final Thoughts

Life insurance cannot stop inheritance tax, but it can make it far easier for your family to handle. By using a trust and structuring the policy correctly, you can provide your loved ones with the funds they need, exactly when they need them,  all while protecting your estate from unnecessary stress and disruption.

At Versed Financial, we help clients design efficient, personalised strategies to protect their legacy. If IHT is likely to affect your estate, let’s talk about whether life insurance could play a role in your plan.

Worried about inheritance tax?
Book a complimentary strategy call with Versed Financial today and take the first step toward protecting your legacy.

‘Estate and inheritance planning is not regulated by the Financial Conduct Authority.’