Nearly 7,500 families in the UK paid inheritance tax (IHT) on life insurance policies in the 2022/23 tax year, a charge that could have been avoided if the policies had been placed in trust, according to NFU Mutual.
HM Revenue & Customs (HMRC) data showed that of the 31,500 estates that paid IHT, almost a quarter included life insurance policies. The combined value of these policies was £865 million, meaning up to £346 million may have been collected in tax.
Under UK rules, life insurance payouts are usually included in the value of an estate for IHT purposes unless the policy is written into trust. Placing a policy in trust typically means the proceeds are paid directly to the beneficiaries, bypassing the estate and avoiding the 40% IHT rate, as well as speeding up payment by avoiding the probate process.
Sean McCann, chartered financial planner at NFU Mutual, noted that many people buy life insurance without advice and are unaware of the tax consequences. He said that setting up a trust is “relatively straightforward” and often free of IHT implications, provided the policyholder is in good health at the time.
However, if the individual is seriously ill when transferring the policy into trust and dies within seven years, HMRC may still seek to include the policy’s value in the estate.
The issue comes as more families are drawn into the IHT net. HMRC collected £6.7 billion in IHT in 2022/23, a 12% increase on the previous year, with frozen tax-free thresholds until 2030 expected to expand the number of estates liable for the levy. This trend is also affecting insurance planning, as rising property prices, larger investment portfolios and higher savings balances push more estates over the £325,000 nil-rate band.
Meanwhile, industry professionals warn that without proactive estate and insurance planning, life insurance, often purchased to provide financial protection to dependants, can inadvertently add to the tax bill. The Association of British Insurers (ABI) has previously urged policyholders to review how their life cover is arranged, particularly as families increasingly rely on insurance payouts to cover debts, living costs and funeral expenses.
McCann stressed that with frozen thresholds and rising asset values, reviewing life insurance arrangements is becoming an important part of wider financial and estate planning.
“It’s all the more important that families don’t pay inheritance tax on life insurance policies unnecessarily,” he said.
