The government has climbed down somewhat on its treatment of Trusts for Inheritance Tax purposes but is life insurance still an option for paying the bill?
Earlier this year, the government announced a crackdown on the use of certain trusts set up to mitigate Inheritance Tax (IHT) bills. Over the next few months, following much lobbying from dismayed legal and financial services industries, not to mention the public, there was a considerable amount of back tracking.
Even so, now that the various amended changes have become law, IHT specialists are still trying to grapple with complex rules that are now applicable to accumulation and maintenance trusts, interest-in-possession trusts and life insurance policies written in trust.
It's the life insurance aspect that I want to tackle in this article although, as ever, if you want to mitigate the inheritance tax liability for your estate, you absolutely must go to a specialist for advice. The issue of avoiding IHT has always been a minefield and now it's even worse so always use an IHT specialist if you don't want your heirs to be lumbered with an IHT bill.
As you know, IHT is payable at the rate of 40% on any money you leave over and above £285,000 (for the year 2006/07). There are myriad ways of getting around this but one is to buy a 'whole of life' insurance policy that pays out enough money to cover the anticipated inheritance tax bill upon death. Even with the new rules this is still possible.
First, however, the policy has to be written in trust to ensure that the proceeds fall outside your estate and this still applies under the new rules. However, you have to be careful about the type of trust you use.
The simplest is when the life insurance policy is written in a 'bare trust'. This means that the payout is guaranteed upon death and that if there is an IHT liability, your children are given the insurance money to cover the bill.
More complicated is when the policy is written in an 'interest-in-possession' trust where the payout is also guaranteed but goes into the control of trustees who have the power to dish out the money as and when they consider it appropriate. In this instance, the money is effectively subject to a new tax of up to 6% depending on when the trustees pay the money to the beneficiaries. The 6% is fully payable every ten years but that's still a smaller bill than the 40% that could be due in IHT though.
The main drawback with using life insurance to cover an IHT bill is the cost. Depending on what type of policy you take out, at what age and how much for, the premiums could escalate over time so as to be virtually unaffordable. So, I repeat, go to a specialist such as a Wills & Trusts solicitor, or a financial adviser specialising in life insurance and tax planning!
Many thanks to the Association of British Insurers for their help with this article
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