When you pass away, an unexpected IHT bill can leave your beneficiaries reeling. Paying it reduces the amount of wealth that you have left them. It can also – if they only have access to illiquid assets – leave them struggling financially.
As part of your wider financial planning activities, you might already understand how reliefs and exemptions can be used to reduce IHT; you may also be familiar with gifting rules. However, if you have not considered life insurance as part of your IHT mitigation strategy, you could be missing an opportunity.
In this UK IHT planning guide, we will discuss how life insurance can be used for those deemed UK domiciled and non-domiciled. We will also share expert commentary and case study highlights from Chris Yardley, our Client Director, and Peter Sayers, our Head of International Business Development.
How can you mitigate IHT with life insurance?
Simply purchasing a life insurance policy is not enough when it comes to IHT planning. In fact, doing so – without appropriate guidance – may mean that the policy payout is included within your estate and, therefore, subject to IHT at a rate of 40%.
Writing life insurance in trust
To use life insurance to mitigate or fund IHT obligations, your policy must be written in trust. By doing this, you are effectively giving up ownership of your policy; the trust and its trustees will legally own it.
There are a number of benefits associated with having your life insurance written in trust:
- It ensures that the policy payout is outside of your estate for IHT purposes.
This means that there is no IHT payable on the payout itself.
- It gives you more control over your policy payout.
With the payout no longer classified as part of your estate, it can be given to the intended beneficiaries in full – it cannot simply be used, for example, to cover other debts.
- There is no need to apply for probate.
As the trust and its trustees legally own your life insurance policy, they can obtain the money from the policy without probate. Beneficiaries who must apply for probate may find themselves waiting months, or even years, to access the money.
Altogether, this not only protects your loved ones from having to pay an unexpected IHT bill, it also ensures that their financial needs are taken care of – quickly – during an emotionally tumultuous time.
Before writing your policy in trust, it is best to discuss all potential advantages and disadvantages – and how they may apply to you and your loved ones – with your financial adviser.
How to write life insurance in trust
A summary of the basic steps involved in writing life insurance in trust are as follows:
- Determine the sum assured that is right for you and your unique situation
What do you want to achieve with your policy payout? Are you the main breadwinner; do you need to help your spouse cover mortgage payments and school fees? How much IHT will your beneficiaries have to pay? Will you want to use part – or all – of the payout to cover the liability? With careful IHT planning and cash flow exercises, your financial adviser will be able to help you determine the best sum assured for you and your loved ones, with a certain degree of flexibility should your circumstances change.
Note that the sum assured is not something that you can simply ‘set and forget’. “Estate values, costs and circumstances are liable to change,” Chris points out. “Policies should be reviewed on a regular basis to ensure that they continue to match your requirements.”
- Find the life insurance policy that is best suited to your situation and your IHT planning strategy.
Whole-of-life (WOL) policies are most recommended for IHT mitigation purposes. However, depending on your financial objectives and your future plans, there may be alternatives for you to consider.
WOL policies typically have the highest premiums. This is because the provider knows that at some stage, you – the policyholder – will die and a payout will be required.
When it comes to IHT planning, Chris warns against avoiding certain policies to reduce costs: “There are many subtle differences between policies; a full assessment should take place rather than simply selecting a policy with the cheapest premiums.”
- Decide which trust is right for you and appoint a trustee (or trustees).
While most insurance providers make it fast and easy for you to write your policy in trust, it is important to dedicate time and thought to the type of trust that is right for you, and it can be helpful to engage a lawyer to review the trust deed. Choosing and appointing the most appropriate trustee (or trustees) is also imperative, be it family members, a trusted solicitor, or a family office.
While this process might seem straightforward enough, the IHT planning process is complex. We strongly recommend seeking professional financial advice before simply writing your policy in trust. Doing so ensures that your strategy is robust and that your loved ones are well and truly protected.
UK IHT planning for individuals deemed UK domiciled or non-domiciled
Regardless of whether you are classified as UK domiciled or non-domiciled, our team of financial advisers can provide you with the independent, tailored advice that you need to shield your loved ones from an unexpected – or unaffordable – IHT bill.
In the sections below, Chris and Peter share some of their experiences with IHT mitigation for individuals and family offices, with highlights from two of their most recent case studies.
IHT planning for non-domiciled UK residents
Chris tells us about a couple that he recently advised on IHT planning. Both were in their late 40s and in relatively good health. Most of their assets were jointly owned; the majority of which were in the USA and Australia. Their combined total wealth was around £7million.
“Both had been resident in the UK for five years, so under the UK’s domicile rules, they had another 10 years of residency before they would be deemed to be UK domiciled,” Chris states. “But, the husband was born in Oxford, therefore he had a UK domicile of origin. Consequently, his worldwide assets had already been brought under the scope of UK IHT.”
How much life insurance cover is need?
After considering the nil rate band and other IHT allowances and exemptions, Chris determined that their combined IHT liability would be approximately £1.5 million. His next task was to work out the appropriate sum assured.
“Their primary reason for taking out a life insurance policy was to protect against UK IHT,” he reveals. “The secondary reason was to cover education costs – their two children wanted to attend American universities, which are costly. In the event of his death as the sole breadwinner, these costs could not be afforded without selling assets that are illiquid, based overseas and carrying chargeable gains.”
The resultant sum assured was £1.8 million, however Chris points out that his clients are still unsure of their retirement plans; “They expect to retire in Australia, but this may change, so flexibility is required.”
Which life insurance policy will help reduce IHT?
A situation-appropriate whole-of-life (WOL) policy was selected for the couple. “If they retire in Australia, the husband should lose his deemed domicile status after six years of non-residency,” Chris begins, “but they might retire in the UK, in which case his worldwide assets will continue to be exposed to UK IHT and hers will be after 15 years of residency.”
As such, Chris advised them on a joint-life second death policy, which ensures that they and their loved ones will be covered if they decide to retire in Australia. He also established a smaller single-life term policy to run for the duration of their children’s education, so if the breadwinner dies, their children will have the funds available to afford university education in the US.
“The WOL policy is flexible and can be cancelled at any time,” he concludes. “Its terms are guaranteed for the first ten years. After this, the premiums will rise, to possibly more than double.” While this might seem like an expensive option, Chris explains: “In this case, a guaranteed WOL policy was not appropriate due to their uncertain retirement plans. If they move to Australia, after six years, they are likely to cancel the insurance.”
UK IHT planning for non-residents
As part of our international team, Peter provides financial advice to family offices and fiduciaries.
“We do a lot of work with clients that are not British, but have strong connections to the UK,” he reveals. “Many of them are working with other professional advisers: lawyers, tax advisers, offshore fiduciary groups.”
He introduces us to an IHT mitigation case that he is currently working on. Three Nigerian owners of a successful oil business have appointed a family office in Jersey to take care of their financial matters.
He points out: “even though these clients have a significant net worth, their personal liquidity position is not good. They are very conscious that, if something happens to them, there would not be a lot of cash available for tax liabilities or any other obligations, including school fees and mortgages.”
While the business partners are all Nigerian citizens and resident in Lagos, each one of them owns property in the UK. They typically spend between three to four months in the UK each year due to the strong connections that they have here – for example, children in boarding school.
Peter liaises directly with the family office. The office assumes full responsibility for paying policy premiums. It also acts as a trustee.
Determining the appropriate sum assured
Before selecting the most appropriate life insurance policy, Peter informs us: “We go through an exercise to quantify not just their IHT liability, but also any other obligations that they have. This allows us to arrive at a sum assured that is best for their personal circumstances.”
“In this case, the primary driver for them to arrange insurance is their IHT liability,” he continues. “They have no interest in selling their houses and they accept that there is an unavoidable tax liability. Therefore, they want to ensure that, if something happens to them, their life insurance policy will guarantee that there is immediate liquidity available to the family office.”
“The value of their shareholdings in the business can be realised, but that is going to take time,” Peter cautions. “That does not help the family as the tax liability and other obligations need to be met in the short-term. Here, trustees have the comfort of knowing that there is access to cash immediately after. Without that liquidity, they are going to struggle. You cannot pay an IHT liability to HMRC with a promise.”
Finding the right life insurance policy: sourcing from the international market
When it comes to selecting the best possible policy, Peter discloses: “we must go to the international market if you are not UK resident; we cannot use traditional onshore insurance.”
If you are resident in a country that is known as a ‘high-risk jurisdiction’ – such as Nigeria – it is essential to seek advice from an adviser with global experience and up to date knowledge of the international market. “If you go to an adviser who only has access to normal UK household names, you will quickly find that they are unable to secure life insurance for you,” Peter forewarns.
Your adviser must know which international providers will be willing to insure you; they will also need to understand which ownership structure is most appropriate for you. Peter reveals that, if they do not, “the policy that they select for you might not deliver the correct solution.”
He adds: “In situations like this case study, you want to have your trust structure and the structures that own your shareholdings outside of Nigeria (or your country of residence). You also want to have life insurance outside of the country.”
How to help protect your loved ones from an unexpected – or unaffordable – IHT liability
Regulated in the UK and the EU, the Strabens Hall Group provides expertise in financial planning, wealth structuring and investment advice. To find out how our how we can help you protect your loved ones’ financial wellbeing when you pass, contact our London or Nice office.