Life Insurance and Tax

Can my Life Insurance be taxed?

There are a number of life plans that can be used to pay any potential death tax bills your family may have and this is done by setting a plan into trust and by doing this ensures that the life insurance pay-out no longer forms part of your estate and can be used to clear your tax bill by your loved ones. This can be especially helpful if the estate is worth more than the sum assured. 

We will act only as introducers for any investment or IHT issues.

Gift Inter Vivos

Gift Inter Vivos is a form of term insurance that is set up to cover any potential inheritance tax bill you may create when giving a sum of money away to your family for example. The aim of Gift Inter Vivos is to provide a lump sum if you die within the set 7 year period. The Gift Inter Vivos Life Insurance plan is designed to cover the liability on inheritance tax on a Potentially Exempt Transfer (PET) that is to cover the nil rate bands for inheritance tax. If you plan to give parts of your estate away whilst you are alive, you may be liable for IHT within the first 7 years of the gift. The plan allows people to gift their estate to their loved ones and covers the potential tax bill should they die while the gift is liable for tax. An Inter Vivos trust is often used synonymously with the more common term Living Trust, but an Inter Vivos trust, by definition, includes both revocable and irrevocable trust.

Please find below the amount of tax which would be owed over the 7 years. The Gift Inter Vivos sum assured reduces at this rate:

  • Within 1 years 100%
  • Within 2 years 100%
  • Within 3 years 100%
  • Within 4 years 80%
  • Within 5 years 60%
  • Within 6 years 40%
  • Within 7 years 20%
  • After 7 years 0%

These figures are correct as at April 2013.

Usually a life insurance plan is not liable for income or Capital Gains Tax, however without putting your plan into trust your life insurance plan could be subject to inheritance tax. If the lump sum pay-out pushes your estate over the £325,000 threshold for single people and £650,000 threshold for a married couple there could be a tax bill to pay.

The trust option is completely free of charge and can help you to avoid inheritance tax. By putting the plan into trust when the policy pays out, the money gets paid to the trust and not added to your estate and because it goes to the trust and not your estate the tax man cannot touch it. The money will be paid to your beneficiaries, with the help of the Trustees.

As the trust will avoid probate and does not need to wait for a will to be read, it is the fastest way for your loved ones to receive the money.

The Financial Conduct Authority does not regulate tax and trust planning.

Infomation regards taxation levels and basis of reliefs are dependent on current legislation, individual circumstances are not guaranteed and may be subject to change.

What is Inheritance Tax?

Inheritance tax was originally invented to tax the rich in the event of them passing away and leaving land or properties to their children. It was never intended to affect common people, however as the law has not been updated for many years, most people could be faced with a tax bill. You are taxed for everything in your estate over the nil rate band. The nil rate band is the amount up to which an estate pays no inheritance tax.

As the price of houses rise in the UK faster than UK laws being passed many people now own their own homes. This means that when they die they could face an inheritance tax bill to pay which will reduce the sum of any money left to the beneficiaries. You may be below the IHT threshold now but will that still be the case in perhaps 30 years’ time? A recent nationwide survey shows that in the last 30 years we have seen the average house prices rise from £1,391 to £163,560, whilst the nil rate band has only risen from £55,000 to £325,000, this pushes many home owners closer to the nil rate band compared to 30 years ago and people are often surprised to be faced with a potential tax bill.

In 1983 many people’s estates were worth a lot lower than the nil rat band, in fact the average house price was 39 times below the figure. Planning for a potential tax bill did not feature in many people’s plans. In today’s society it is very different, the nil rate band thresholds is just over half the value of the average house price. If house prices keep rising at the current rate and the nil rate band stays static many more people could find themselves with a potential tax bill. Please speak to a Proadvice specialist today to talk about what options are available to you.

The rate of Inheritance Tax is 40% on anything above the threshold (‘nil rate band’) and the IHT bill is to be paid within 6 months of the deceased, passing away.

There are a number of exemptions with Inheritance Tax that can still be claimed, even if your estate is over the threshold. Examples of these include;

  • Spouse or civil partner exemption. Your estate usually does not owe Inheritance Tax on anything you leave to a spouse or civil partner who has their permanent home in the UK
  • Charity exemption. Any gifts you make to a 'qualifying' charity in your will or during your life time will be exempt from Inheritance Tax
  • Potentially exempt transfers. If you are to survive for seven years after making a gift to someone, the gift is generally exempt from Inheritance Tax, no matter what the value may have been
  • Annual exemption. You can give up to £3,000 away each year, either as a single gift or as several gifts adding up to that amount
  • Small gift exemption. You can make small gifts of up to £250 to as many individuals as you like tax-free
  • Wedding and civil partnership gifts. Gifts to someone getting married or registering a civil partnership are exempt up to a certain amount.
  • Business, Woodland, Heritage and Farm Relief. If the deceased owned a business, farm, woodland or National Heritage property, some relief from Inheritance Tax may be available. (1)

1. http://www.hmrc.gov.uk/inheritancetax/pass-money-property/exempt-gifts.htm

Infomation regards taxation levels and basis of reliefs are dependent on current legislation, individual circumstances are not guaranteed and may be subject to change.

Who pays inheritance tax?

Any deceased person’s estate which exceeds the inheritance tax threshold is subject to Inheritance Tax and is usually arranged by the Executor of the estate. The Executor will arrange for the money from the estate to pay the Inheritance Tax bill yet in some cases due to the tax needing to be paid within 6 months, if the property has not been sold or the Executor has failed to raise the funds, sometimes the Executor will have to borrow money or draw down from their own funds to clear the tax bill. The Executor is then usually reimbursed from the estate before the beneficiaries receive any payment.

If you have paid inheritance tax bill for someone else you are entitled to claim all the money back from the estate. This can be done once probate has been granted.

What is a trust?

When taking out a life insurance policy, we at Proadvice, recommend setting the plan into trust. A life insurance trust will allow you to choose who you want your money to go to in the event of your death. Doing this is referred to in the insurance industry as ‘writing in the trust.’ 

Putting your life insurance policy into trust will mean that in the event of your death, the pay-out from your life insurance policy should be free of inheritance tax thus ensuring your family will receive the full sum assured.

When you set your life insurance policy into trust you become what is referred to as the Settlor. By putting the plan in trust, you are ensuring that your loved ones receive their pay-out and receive it quickly. As the sum assured does not form part of your estate, the pay-out does not have to wait for a will to be read or for probate to be completed.

With your trust you will also get to choose who will receive the money in the event of your death. The recipient of the money is called a beneficiary. A trust comes into force on your death; and as you are no longer there to explain what you would like to happen to the money, you are required to appoint Trustees to act on your behalf. The Trustee acts in a very similar way to an Executor of a will. The Trustees will ensure that the life insurance sum assured is dealt with in accordance with your wishes. 

The Financial Conduct Authority does not regulate trusts.

If you have any more questions about Life Insurance and Tax please get in contact. Please find below some information about Income Protection that you may not have considered before.

What type of Income Protection Plans are there?

 There are two main types of income protection plans. There are long term income protection plans such as permanent health insurance and there are short term plans such as ASU, (Accident, Sickness and Unemployment) and PPI (Payment Protection Insurance) and MPPI (Mortgage Payment Protection).

This Payment Protection Insurance is optional. There are other providers of Payment Protection Insurance and other products designed to protect you against loss of income. For impartial information about insurance, please visit the website at www.moneymadeclear.org.uk

The short term insurance plans are normally taken out to cover a debt or mortgage and there are usually no medical questions required to be asked. The short term plan is open to almost anyone in employment and as there are usually no medical questions, the plans often just have full blanket exclusion on all pre-existing medical conditions no matter how long ago they were. The insurance plans normally have a restricted pay-out period of one or two years and have to be reviewed every year due to the fact the plan is a general insurance plan the terms and conditions are subject to change. If you are to claim on your plan in year one and have a two year policy, the insurance company may decide to exclude the condition you have suffered, going forward.

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