Will My Life Insurance Be Subject To Inheritance Tax?

Inheritance tax is paid on some gifts or trusts and on an estate of an individual who dies.

Not all UK residents are required to pay inheritance tax.

This charge is only imposed if the estate’s value exceeds the inheritance tax threshold that tends to vary annually. For 2013-14, the threshold is £325,000. The tax is 40 percent of the amount over the threshold and 36 percent if a charitable donation qualifies the estate for a reduced rate.

Who Pays Inheritance Tax?

When an individual dies, the personal representative or executor of the deceased’s estate is usually responsible for paying the inheritance tax. The estate is valued by adding up the values of all included assets and deducting debts, including funeral expenses, owed by the deceased.

The deceased’s share of assets that were jointly owned and the value of assets held in trust are included in the estate. If the deceased made gifts during his or her lifetime, which are not exempt, they must be included in the estate’s value. Funds from the estate are used to cover the payment.

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Most situations require the payment of inheritance tax within six months of the end of the month in which the individual died.

After this time, any outstanding amount will be subject to interest charges. If the value of the estate is tied to a home or other property, inheritance tax can be paid in annual instalments over ten years.

Since September 2009, the interest rate for inheritance tax has been three percent and the interest on instalment payments has been 0.5 percent.

Increasing the Threshold

Since October 2007, registered civil partners and married couples have been entitled to increase the inheritance tax threshold on their own estate when the other individual dies. In 2013-14, this estate can be increased to a maximum of £650,000.

The personal representative or executor must transfer the unused inheritance tax threshold to the other civil partner or spouse upon the death of the first individual.

If the deceased leaves an asset to a civil partner or spouse whose permanent home is in the UK, the estate typically will not owe inheritance tax on this, even if the amount exceeds the threshold.

Using Life Insurance to Reduce Inheritance Tax

If you suspect that your estate will owe inheritance tax upon your death, a life insurance policy can be used to reduce this tax.

Purchasing a whole of life policy that covers the inheritance tax that will be due passes more money to beneficiaries.

To ensure that the policy benefit is not included in the estate, the policy must be written in trust. An added benefit of a whole of life policy is that the premiums paid reduce your estate value while you are still living.

An alternative is to give away part of your estate while you are still living. Dying within seven years of making this gift may subject the estate to inheritance tax but the tax declines over this period.

By purchasing a seven-year decreasing term policy, you can cover a potential inheritance tax liability so beneficiaries will not need to pay the tax out of the estate.