Why life insurance plans might hold the key to your tax-efficient estate planning

Recent and upcoming Inheritance Tax (IHT) changes mean that now could be the perfect time to revisit your estate and legacy planning.

Back in October 2024, Rachel Reeves delivered her first Budget. Alongside plans to abolish so-called “non-dom” status and a reduction to Agricultural Property Relief (APR) and Business Property Relief (BPR), the chancellor also announced reforms to the IHT treatment of pensions, effective from 2027. Reeves also extended the current freeze on the nil-rate and residence nil-rate bands until 2030.

Unsurprisingly, the Treasury’s IHT take is rising. Receipts reached a record £8.2 billion in 2024/25, according to Money Marketing, while the Office for Budget Responsibility (OBR) expects the figure for 2025/26 to top £9.1 billion.

If you expect to leave a significant IHT liability on death, you’ll want to limit the stress and financial strain for those you leave behind. One way to do this might be through life insurance policies held in trust.

Keep reading for everything you need to know.

You might use a combination of life insurance policies held in trust to cover a potentially large IHT liability

If you expect to leave a significant IHT liability on death, taking steps to cover this bill now will give you and your loved ones peace of mind. You’ll also relieve some of the stress your family might otherwise face after you’re gone, at what will already be a difficult time.

One such step could be a life insurance plan (held in trust) with a sum assured aligned to the value of the expected liability.

However, where an IHT bill stretches into the hundreds of thousands – or even millions – the cost of this cover could be significant. This is where expert advice can help you implement the right tax-efficient strategy for you, starting with managing the taxable value of your estate.

Gifting, the seven-year rule, and HMRC’s taper relief

You can lower the value of your estate that is within the scope of IHT through gifting.

While some gifts (those that make use of certain HMRC exemptions, for example) immediately fall outside the IHT net, others will be classed as “potentially exempt transfers (PETs)”.

These gifts are only IHT-free if you survive for seven years from the date the gift is made. On death within three years, IHT is generally due at the full rate of 40%, with taper relief lowering the rate payable until year seven, as follows:

Source: Gov.uk

The earlier in life you begin passing on a living inheritance, the better chance you have of living for seven years, rendering the gift IHT-free. If you know you want to leave a legacy to children, consider giving while living as a tax-efficient alternative to an inheritance on death.

Where a significant IHT liability will still exist, life insurance could help to cover the bill.

A combination of life insurance policies

One way to cover a large bill is by setting up a single whole of life policy to cover your full IHT liability on death. However, this can be costly.

Instead, you might opt to use a whole of life plan to cover sizeable assets, like property, while gifting other assets throughout your lifetime to lower the value of your estate.

You can then take out a series of term assurance plans to cover your tax liability at different ages, as the value of your estate slowly reduces. This approach means each term assurance plan will cover a smaller amount, making it progressively cheaper and less expensive than a single whole of life plan.

Decreasing term assurance plans, meanwhile, can be set up to cover the decreasing liability attached to individual PETs, aligned with taper relief and the so-called “seven-year rule.”

The importance of trusts

To ensure that any life insurance payouts don’t form part of your estate – and so become liable for tax at 40% – your protection plans can be written in trust to a beneficiary, effectively ringfencing them. The payout, on your death, is received by the trust’s beneficiaries, who can use the money to pay the IHT bill.

Paying directly to beneficiaries also removes the need for probate and can speed up the process of receiving funds, reducing stress for your loved ones.

Setting up a trust now allows you to decide who you want your beneficiaries to be, but these are legally binding, and the process can be complex, so be sure to speak to us first. We can advise on the “right” type of trust for you and help to ensure any stipulations you make will be adhered to.

Get in touch

With an increasing number of estates being drawn into the scope of IHT, it’s sensible to revisit your legacy and estate plans. Your financial plan is robust and adaptable, but if you have any questions or concerns about recent or upcoming tax changes, please reach out to your Foster Denovo adviser by emailing advise-me@fosterdonovo.com or calling 0330 332 7866 for more information.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

Note that life insurance and financial protection plans typically have no cash in value at any time, and cover will cease at the end of the term. If premiums stop, cover will lapse. Cover is subject to terms and conditions and may have exclusions. Definitions of illnesses vary from product provider and will be explained within the policy documentation.

The Financial Conduct Authority does not taxation advice and estate planning.

Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief. Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.