Life insurance is often taken out to provide financial security, but many policyholders in the UK may be overlooking a costly oversight: the way their policy is structured could expose their beneficiaries to unnecessary Inheritance Tax (IHT).

In the 2022/23 tax year, HM Revenue and Customs (HMRC) data shows that nearly 7,500 estates included life insurance policies, which represents almost a quarter of all estates paying IHT.

These policies were worth around £865 million, potentially resulting in £346 million in IHT paid that could have been avoided.

How can you keep your life insurance out of Inheritance Tax?

By default, life insurance payouts form part of the deceased’s estate and are, therefore, liable for IHT at the full 40 per cent on any value above the nil-rate band, unless structured otherwise.

Putting a life insurance policy into trust ensures the payout bypasses the deceased’s estate and goes directly to beneficiaries.

This not only mitigates IHT but also speeds up access to funds, since payouts do not require probate.

When might trust placement not protect you?

Trust placement is usually straightforward and free of IHT implications if done while you are in good health.

However, if you transfer a policy into trust when seriously ill, and then pass away within seven years, HM Revenue and Customs may still include it in your estate.

It is now more important than ever to consider how to structure your finances to mitigate IHT.

IHT relief thresholds are frozen until 2030, while asset inflation means more estates are tipping over the £325,000 nil-rate band and £175,000 main residence allowance.

Additionally, upcoming changes, like bringing pensions into the estate for IHT from 2027, may increase liabilities further.

If you hold a life insurance policy, now is the time to ask your provider for a trust form.

Ultimately, although life insurance is supposed to protect your family’s financial future, it can end up increasing your IHT bill if not properly managed.

Keep control of your financial future by speaking to our team today.