How insurance could spare your family an inheritance tax nightmare

Telegraph Money explains how to make life easier for relatives facing a large bill

This year, an estimated 40,000 families will be landed with an inheritance tax bill worth potentially hundreds of thousands of pounds.
One of the most unpleasant things about inheritance tax – charged on the part of an estate worth more than £325,000 – is that the individual whose estate incurs the 40pc levy will not be the one dealing with the final bill.
Instead, their family will have to calculate the tax owed and pay the liability within six months of the death – often before they have access to the money you’ve left behind.
However, it is possible to make life easier for your relatives by putting some money aside to pay the bill.You can do this by setting up an insurance policy that will pay out when you die.
Remember that any insurance policies you have will be included as part of your estate, meaning the final tax bill could end up even higher.
This is why you must write the policy into a trust. Many insurance providers will do this free of charge.
One of the advantages of paying inheritance tax via a life insurance policy written into a trust is it reduces the risk of your family having to pay interest on the tax bill.
Interest will be due on inheritance tax if the family fails to pay the bill within six months. HMRC currently charges 7.75pc on late payments.
Some families end up paying the bill late through no fault of their own because of probate delays.
A grant of probate is needed in order to sell the home of the deceased. With grants currently taking up to 11 months, some families are being left without the proceeds from the sale to cover the bill, forcing them to incur interest on their late payments.
However, a grant of probate is not required to access a trust. Often a trustee just needs a death certificate.
Here, Telegraph Money explains the different policies that are out there and how to choose the best one for you.
A married couple both aged 70 could expect to pay around £330 a month for a whole of life policy paying out £200,000 on death, according to estimates by wealth manager Evelyn Partners.
They would need to live more than 50 years before they paid more in premiums than the sum assured.
The premiums will be higher if you have health issues and also the older you are.
For example, a couple both aged 80 could expect to pay around £630 per month.
Once you are above age 80, it becomes more difficult to secure the terms and so there is likely to be a cap on how much the policy will pay out.
These figures assume no commission so they could be higher depending on which adviser you use.
Ian Dyall, of Evelyn Partners, said: “Care needs to be taken regarding which whole of life policy to use. They are not all equal and it is easy to get seduced by lower premium policies, which can be a costly mistake.
“The best policy for this purpose is a ‘guaranteed’ whole of life policy. These are more expensive at the outset than other alternatives, but the premiums are guaranteed not to increase, even if you live much longer than expected, which means that they should remain affordable until death.”
By comparison, with reviewable whole of life policies, the premiums are subject to change as you get older. Mr Dyall said he had seen clients with these policies whose premiums had grown eightfold. This can mean the policy lapses or the sum assured is significantly reduced.
Married couples should get a joint life second death whole of life policy as this is cheaper than a first death policy. Inheritance tax is usually only due on the second death because spouses can transfer assets between themselves tax-free.
However, there are some whole-of-life policies that pay out on the second death only within a set term, usually age 90.
“Although they are heavily promoted as a means of paying inheritance tax, the chances of one of the spouses living beyond 90 is fairly high, so all those premiums could be wasted,” said Mr Dyall.
Life insurance can also be used to cover the liability that arises when gifts are made within seven years of the person’s death.
Sean McCann, of insurer NFU Mutual, said: “For those making non-exempt gifts who are concerned that they may die within seven years, it’s important to remember that outright gifts ‘eat’ the £325,000 tax-free allowance first. The loss of part or all of the allowance could be protected by taking out a seven-year ‘temporary life insurance policy’.
“For outright gifts over the tax-free allowance, if you survive more than three years, the inheritance tax due tapers down. As an example, if you gave away £100,000 more than the tax-free allowance, and died within three years, the potential inheritance tax bill would be £40,000. If you died between years three and four the tax bill would be £32,000, years four and five it would be £24,000, years five and six £16,000, years six and seven £8,000, before reducing to zero after seven years.” 
A so-called ‘gift inter vivos policy’ provides cover that reduces in line with the liability.
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