Chapter 9 Insurances

We now look at how you can use insurances to pay for the IHT. Don’t be fooled here. Insurance is NOT avoiding the tax – it is providing the means for your loved ones to pay it. Since insurers provide insurance to make a profit it must follow that in the economy as a whole it would be cheaper not to insure and for everyone to pay the tax due. However that is not the point of insurance, which is to spread risk, albeit at a cost. 

Insurance can pay high commissions, so beware of advisers trying to make  a quick buck. Be very careful to calculate both the value of your estate and how much you can afford to pay. A large proportion of plans are cancelled, which suggests that they are not well understood either by consumers or advisers.

If you run a business, make sure that your adviser understands Business Property Relief. I have seen cases where insurance has been taken out where there was no Inheritance Tax liability!

There are two main types of insurance that are used for IHT planning:

“Gift inter vivos” insurance

This is an insurance plan that is used to cover the Inheritance Tax liability on a gift. It lasts for seven years and the cover reduces to reflect taper relief. The policy is placed in trust for the recipient of the gift. The premiums you pay are treated as gifts, reducing the amount available for your annual gift exemption. You only need this insurance if tax will be due on the gift.

Whole of Life insurance

The way whole of life insurance works is this:

• You take out a whole-of-life insurance contract (see notes that follow)
• On a joint-life, second-death basis (if married/in a civil partnership)
• Put the policy in trust 

The last step is crucial. When the second person dies, the policy pays out – but not into your estate, so there is no Inheritance Tax charged on the proceeds. I have seen cases where the adviser has made his money and failed to organise a trust. 

The insurance policy proceeds on death are then used by your executors to meet some or all of the IHT liability. 

Note that the premiums are gifts, so these either need to be within the £3,000 annual exemption; or you need to be able to afford them without running down your savings; or you need to get your children to pay them. If none of these apply, the excess over £3,000 a year is a chargeable lifetime transfer. Keep very good records.

In the chapter about trusts we look at periodic and exit changes. Normally the value of an insurance policy is low. However, if death (or terminal illness) occurs shortly before a tenth anniversary, the trust (containing the life policy) will have a value – the death benefit. This could lead to some tax being charged at the 6% level (referred to in Chapter 2) if the value of the policy exceeds the nil-rate band.

Whole of life insurance comes in three varieties – “guaranteed”, “balanced” and “maximum cover”. Each is capable of running for life.

Under a guaranteed contract the premiums are guaranteed not to rise and the cover not to fall. However as you are transferring all the risk to the insurer, the insurance company will charge a lot more – the premiums could easily be as much as double the cost of a balanced contract. 

In a balanced cover contract you are taking an investment risk. The premium is split into a savings element and an insurance element. Normally insurance gets costlier as you get older and the savings element builds up and later subsidises the premium. Provided the investment element manages to meet a target set at, say, 6% a year, the premium will not rise during your lifetime. If it beats this target you may find that your cover increases (rather a good idea with IHT) or you might be able to reduce your premium. If investment returns falls short of the target, you may find that premiums rise or the level of cover falls.

On a maximum cover basis, all the premium goes into insurance, and none into savings. This is very cheap at first. After, typically, ten years the premiums have to be renewed. At that time the costs will rise dramatically and the premium may then be unaffordable. This form of cover is really only suitable for use as temporary fix – for example a couple in their fifties may feel unable to give anything away but don’t want to risk a large IHT bill on a premature death.Always shop around for whole of life cover. While many insurers offer the cover, the difference in cost between the cheapest and the average is amazing. Taken over a lifetime, this could run into many thousands of pounds.