Inheritance Tax Mitigation - Insuring Against the Liability

One of the more straightforward ways of dealing with a potential inheritance tax liability is to take out a life insurance to cover the liability.

Inheritance tax will occur on the death of the surviving spouse and so a joint life, last survivor whole of life policy is a useful solution.

The level of life cover to be taken out would equate to the current inheritance tax liability, and through the use of a suitably flexible contract, it is possible to have this cover increased if required in light of changes to client's particular inheritance tax liability.

Unfortunately, as with all areas of inheritance tax planning, even if the seemingly straightforward solution can be complex.

The complexities surround the choice of premium options.

Low-cost whole of life

As the name suggests this type of arrangement is designed to keep the initial cost as low as possible.

This is done by having all of the premium payable being used to provide the necessary life.

This type of policy can be particularly cost-effective in the early stages. For example, a married couple in their mid-40s should be up to get life cover on the basis of around £500,000 for a monthly premium of around £20.

However, the monthly premium is not guaranteed for the life of the contract.  The premium is guaranteed for the first 10 years and thereafter and will be reviewed, typically five-year basis.

The reviews are not based on any further medical evidence but on the fact that the clients are older and therefore the risk of them dying within the review period is higher.

The premiums under this low-cost arrangement do escalate quite dramatically over the longer term. Therefore this low-cost option should really be seen as a temporary stop gap to an inheritance tax liability rather than a long-term solution.

Whole of Life - Standard Basis

Under this arrangement of the monthly premium is significantly higher than the low-cost version. A portion of the premium is used to pay for the cost of the life cover.  The balance of the premium is invested, typically in the life office's balanced managed fund.

The premiums under this arrangement are reviewed in exactly the same way has the low-cost version. The difference here being is that the additional investment fund is used to support the cost of the life cover in the future.  Provided the investment fund returns a target figure, typically 6% per annum the investment growth will be sufficient to support future premium rises and consequently the total premium payable remains constant.

Using our same couple in their mid-40s looking for £500,000 of cover, we would have a starting premium off circa £230 per month under this arrangement.

Whole of Life - Guaranteed Premium

Under this arrangement the contract offers life cover only i.e. there is no investment element.  However, unlike in the two previous versions in the premium is set at a level which is guaranteed not to write and a light certainty of cost.

This is of course a more expensive option and once again our married couple in their mid-40s would pay £380 pounds per month for cover of £500,000.  There are advantages and disadvantages for all very strategy.  The medical and financial underwriting would of course be important in assessing the premium on an intriguing example to show her on the basis that there is no adverse medical history.

Equally, it is important to consider the cost benefit analysis.  Without given that the plan is a whole of life then provided the client continues to pay the premium to the life office, it is definitely going to put out the sum assured. It is important to consider the likely total cost of the life of the policy over the anticipated lifespan of the client compared to the benefit that is going to be paid out.

As with all insurance you are in effect betting against the insurer.  Unfortunately the way to win this particular game is to die earlier than the life office expects you to. It is perhaps not the best basis on which to enter into a contract with a life office!

Alternative Bespoke Structure

Another strategy is to effectively build a bespoke whole of life plan but with more flexibility and better returns should contributions to the plan cease at anytime.

This strategy involves splitting the life cover and investment elements of a whole of life strategy into their constituent parts.

Firstly, a regular savings plan is set up (in trust for your beneficiaries) with the premium set so that over a 25 year period the fund would grow to our target £500,000 based upon reasonable assumptions. This would give a monthly premium of around £500.

We would then combine this with a 25 year decreasing term assurance policy with a starting sum assured of £500,000. This would have a monthly premium of around £55.

The combination of the two plans would provide £500,000 for your beneficiaries to meet the IHT liability through the combination of the life cover and the savings plan.

On the face of it this is a more expensive strategy than the whole of life guaranteed route. However, clients in their mid 40's have a life expectancy of a further 40 years or so. So the total cost of the whole of life plan for 40 years would be £182,400 whereas the bespoke strategy would cost £166,500.

In addition, the bespoke operation provides for greater values for the beneficiaries should it become necessary to reduce or stop the premiums in the future.

Tax Treatment of Premiums and Investment Contributions

The payment of the monies into the policies can be deemed gifts for IHT purposes and so this is an aspect which needs to be looked at carefully. There are exemptions to the IHT gifting rules such as the £3,000 annual allowance and "gifts out of income" which can be used to avoid any lifetime IHT liability arising. However, the use of these exemptions is very specific to each client's personal circumstances and would need to be discussed in more detail on an individual case basis.

Use of Trusts

In order for any IHT strategy to be effective it is essential that a properly worded trust is used. It is essential that correct advice is given in this area as using the wrong type of trust can undermine the whole IHT mitigation strategy.

Personalised Advice

If your gross asset value is in excess of around £550,000 then IHT is an issue you should be considering now.

For a personalised assessment of your current liability and t discuss the options open to you for mitigating this liability please contact Richard Gough by e mail or by phone (029 2034 8630).