Life insurance is something that everyone should give serious consideration to.
Why take out life insurance?
Most people take out life insurance for one of two purposes.
The first (and most commonly known) purpose is to provide for a lump sum for your loved ones should you die unexpectedly. Many employees will receive life cover as a benefit of their employment, but the amount payable may not be sufficient to support your family should you die.
The second most widely used purpose for life insurance, and the subject of this article, is to provide a lump sum for your heirs to help pay the inheritance tax that might fall due on your death.
With the recent changes introduced by the Labour government to inheritance tax, bringing business assets and pensions into the inheritance tax net from April 2026 and 2027 respectively, life insurance should become an increasingly important part of inheritance tax planning.
Life insurance for inheritance tax planning
Life insurance pays out a tax free (so long as it is written in trust, more on which below) lump sum on death of the insured. This is paid out on delivery of proof of death to the life insurance company. There is no need to wait until probate has been obtained, which means that the money can be obtained by the deceased’s heirs fairly quickly, and before any inheritance tax payment falls due (inheritance tax is due 6 months after death).
We always recommend that life insurance is written in trust. This means that the proceeds of the life insurance do not belong to the deceased’s estate but rather to a trust which is a legally separate entity. This ensures that the life insurance proceeds will not suffer 40% inheritance tax. Normally the trustees of the life insurance trust are the heirs or the executors of the deceased so that the proceeds can then be applied to pay some or all of the inheritance tax due.
What determines the cost of life insurance?
The cost of life insurance varies depending on the age and health of the person taking out the insurance. The younger and healthier you are, the lower the cost.
Another key determinant of the cost is the length, in terms of years, that you want to take out life insurance for.
Life insurance can be taken out either to a specified age (though the maximum age you can specify is 90) or you can choose what is called ‘whole of life’ insurance, which will last until an unlimited age, even if you live over 100 years.
Not surprisingly, there is a significant different in cost between life cover that is taken out to age 90 and ‘whole of life’ cover. By way of example, we recently obtained quotes for a client for a) life cover to age 90 and b) whole of life cover. The cost of whole of life cover was 3x more than the cost of cover to age 90. This reflects the fact that insuring against the risk of living beyond age 90 is extremely expensive.
Whether someone chooses to pay the extra for ‘whole of life’ insurance or takes the risk of just insuring to age 90 will depend on the affordability of premiums, their family life expectancy and their consideration of the need for life cover beyond age 90 (for example they might have a plan in place to gift away most of their assets before age 90).
Why should you give serious consideration to life insurance?
Once the new pension and business assets inheritance tax regime has come into effect anything you leave to your heirs above and beyond the various inheritance tax nil rate bands will be subject to inheritance tax at either 20% (qualifying business assets) or 40% (all other assets).
Life insurance (if written in trust) is completely free from inheritance tax. So, it effectively comes with up to a 40% upside for your heirs compared to anything else you leave them on your death.
It is payable on proof of death: so, the funds can be in the hands of your heirs normally within 2 to 3 months of death.
It doesn’t have to be used to pay inheritance tax: it can be used for any purpose your heirs wish.
If you think you would like to consider taking out life insurance, please get in touch
We can talk through your individual circumstances to consider if life insurance is appropriate for you. A key factor is affordability: it is most important that you are able to afford the premiums for the duration of the life cover that you plan to take out. If you cannot afford to keep up with the payments the cover will end and you will not receive back any of the premiums that you have previously paid.
The older you are, or if you are suffering from health issues, the harder it is to obtain life insurance on an affordable basis. Most life insurers will not provide life insurance if you are over age 85. If you have recently suffered a serious illness, in particular cancer, insurers may refuse to offer insurance for a period until they are confident that you have made a full recovery.
Photo by Natalya Zaritskaya on Unsplash