In Focus: Intergenerational Wealth  

How can life insurance help with protecting an inheritance?

This article is part of
Guide to integrating protection with intergenerational planning

How can life insurance help with protecting an inheritance?

Sometimes estate planning can come a cropper. 

Scottish Widows' Chris Dunne notes that potentially exempt transfers, which apply to those whose clients are still living after seven years after the gift is organised through the will, may leave liabilities open for clients’ relatives who die before those seven years. 

In this instance life insurance can help to protect inheritance.

“If the client passes away before the end of those seven years, there is a potential and liability for inheritance tax on this gift.

“In this scenario, a gift inter vivos life insurance policy can mitigate the IHT liability for this gift, in the absence of other exemptions. Obviously the suitability for a gift inter vivos policy depends on the liability of the rest of the estate.”

One other example of protecting against IHT payouts, according to Tony Mudd of St James's Place, is that estate creation can be taken a step further with the process of estate recreation.

The difference in a recreation approach is that rather than attempting to give their assets away, the client can enjoy them – the idea being that, before beginning this journey, they would start a whole-of-life policy that would recreate their estate upon their death.

Mudd notes that every individual has a £3,000 annual gifts exemption – the amount exempt from IHT when it is gifted.

“Using this exemption via premiums into a life policy can be an ideal way to maximise the value of this exemption via a whole-of-life policy in trust payable to their beneficiaries. Similarly, one of the most valuable, underused exemptions is the normal and reasonable expenditure exemption.”

It is important to note that sums gifted within this are also immediately exempt from IHT.

“Again, this annual gift exemption represents an ideal way of passing significant sums to beneficiaries through life assurance contributions into trust,” Mudd says.

With tax rates for IHT looming over the deceased, there are serious considerations to be made regarding protecting inheritance for many people.

Aside from the seven-year tax rule, there are other nuances at play for those placed to take gifts from relatives on death.

For example, if a person died after two years and the gift was drafted in a will and used the total nil-rate band of £325,000, with the balance of £175,000 chargeable at 40 per cent, the total liability would be £70,000.

Canada Life's Neil Jones notes this would fall on the recipient rather than the estate of the deceased.

“It is not uncommon for the recipient to have spent the money or to have used it, say to buy a property, meaning that they would not necessarily have the liquid funds available to pay the tax liability.”

In this situation, if a person was unable or unwilling to pay, HM Revenue & Customs would look for revenue from the estate, which would result in less wealth being transferred to the beneficiaries for which it was intended.