Avoid the £346 million Inheritance Tax mistake: Why you should put life insurance in trust

New research has found that thousands of families could be collectively paying millions more than they need to in Inheritance Tax (IHT).

A report in Insurance Business notes that around 7,500 families in the UK paid IHT on life insurance policies in the 2022/23 tax year. This charge could have been avoided if the policies had been placed in trust.

Taking a life insurance policy and putting it in trust can be a highly effective way of reducing the tax bill on your estate, particularly in light of upcoming changes to IHT. However, it’s important to work with a financial planner to see if it’s the right strategy for you.

Read on to find out why putting life insurance in trust could help save your beneficiaries from paying unnecessary IHT on your estate.

Inheritance Tax receipts are rising and are set to increase further

Statista data shows that IHT receipts have hit record highs for four years in a row. Indeed, the only tax years since 2010/11 that didn’t set a new record were the years between 2019 and 2021.

A major factor behind this rise is the long-term freeze on IHT thresholds, which was recently extended to 2031 in the Autumn Budget. By that point, the standard nil-rate band will have been fixed at the same level for 22 years. As asset values continue to rise, this freeze steadily pulls more estates into the IHT net.

And further changes are still on the horizon. From April 2026, new limits will apply to Business Relief and Agricultural Relief, and from 2027, pensions will be within the scope of IHT. These reforms, combined with the threshold freeze, mean IHT receipts are expected to climb even higher in the years ahead.

So, with IHT bills rising, it’s a good idea to start exploring strategies that can help keep more of your estate for your loved ones. Life insurance can be one such policy, but it’s important that you place it in trust if you want it to remain truly efficient.

There are two main types of life insurance

When it comes to life insurance, you typically have two main options:

• Whole-of-life assurance – This is usually the most effective option for estate planning, as it guarantees a payout whenever you die, as long as you keep up the premiums.

• Term assurance – This only covers you for a set period, so it may not always align with your estate planning needs.

A financial planner can help you choose a policy that’s right for your circumstances.

If you hold a life insurance policy, your beneficiaries will normally receive a payout on your death. According to Forbes, around 97% of policies paid out in 2024, and denied claims are usually due to misrepresentations or failure to disclose certain information.

The lump sum from a policy payout can provide support to your loved ones and help them cover mortgage and debt repayments, school fees, living costs, and other expenses at a difficult time.

Assets in trust aren’t considered part of your estate, including life insurance policies

Assets held in trust are usually excluded from your estate for IHT purposes. This means that the policy payout can go directly to your beneficiaries and avoid both IHT and the delays associated with probate.

However, if you don’t put your life insurance policy in trust, the payout is typically counted as part of your estate and could face a 40% IHT charge.

The report in Insurance Business found that of the 31,500 estates that paid IHT in 2022/23, almost a quarter included life insurance policies. Together, those policies were worth £865 million, meaning up to £346 million may have been paid in unnecessary tax, which is almost £50,000 per estate. Had the policies been written into trust, that tax bill could have been avoided entirely.

It’s important to note that if you die within seven years of placing the policy in trust, HMRC may still treat it as part of your estate.

Moreover, you need to pay the premiums from surplus income, as they will then typically be treated as gifts out of normal expenditure and not be liable for IHT. Whereas, if you deplete capital to pay the premiums, the payments may be charged IHT.

This strategy could be useful considering the upcoming changes to pensions and Inheritance Tax

Pensions are set to become liable for IHT from 2027, which has led many people to restructure their estate plan, as pensions have long been an efficient way to pass on wealth.

While there are several strategies you can employ to help keep your retirement savings efficient when you pass them on, paying them into a life insurance policy held in trust is particularly effective.

In this scenario, you are essentially moving money from your pension into the policy until the policy provides a tax-free payout for your beneficiaries.

Of course, the policy could be expensive and there are multiple factors to consider before doing this, not least how it will affect your retirement income, so it’s important to speak to a financial planner first.

You can read about how to overcome the upcoming changes to pensions and IHT in our previous article on the topic.

A financial planner can help you incorporate life insurance into your estate plan

A financial planner can help you at every step of incorporating life insurance into your estate plan.

They can help you choose a policy and then find a trust that’s suitable for your circumstances. They can then work alongside other professionals, such as solicitors, to ensure the trust is properly established and remains compliant.

A financial planner can also help you understand if life insurance is right for you. Premiums can be expensive, and if you stop paying them, you may get little or nothing back. The cost of premiums can also increase over time, so it’s important to factor this into your long-term plan.

To find out more about how life insurance could play a role in your estate planning process and if it’s right for you, get in touch.

Email info@mlpwealth.co.uk or call us on 020 8296 1799.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.