HMRC doesn’t just tax your money when you’re alive, it swoops after you die as well. On death, the total value of all your assets – including things like your family home and car – must be totted up to assess their total value. Any debts are subtracted.
If the net total is higher than the £325,000 nil-rate IHT band, your family could be taxed on the surplus at a punitive rate of 40%.
Families may also benefit from the main residence allowance, which allows them to pass on a further £175,000. This applies when handing the family home to direct descendants such as children and grandchildren.
IHT is notoriously complicated and it’s all too easy to slip up. Now financial specialists NFU Mutual have highlighted a simple but highly costly error that families keep on making, year after year.
Around 7,000 families a year throw money away by failing to complete a simple piece of paperwork.
The average loss is a staggering £48,000 and families need to check if they’re making this mistake now.
The mistake is failing to put your life insurance policy into trust.
Life insurance policy payouts can run to hundreds of thousands of pounds. The cash is goes to loved ones free of income tax and capital gains tax.
But there’s a catch.
If the value of the life policy payout lifts your total assets above the rate nil-rate threshold, it may become subject to IHT.
Luckily, it’s quite simple to avoid this. Completing a trust form freely available from your insurer will do it.
Yet thousands don’t and pay a heavy price.
New figures show that a total of 27,800 British estates paid IHT in the 2021/2022 tax year. Of these, 6,810 included life insurance policies.
These policies were worth £819million in total. If they incurred the 40% IHT charge families would have handed over up to £327million to HMRC, unnecessarily.
The average cost is £48,000 per family.
Sean McCann, chartered financial planner at NFU Mutual, said many buy life cover without independent financial advice, often on a comparison site. “So they aren’t aware that if they don’t put the policy in trust it’s included in their estate and could end up being taxed at 40%.”
The good news is that putting life insurance policies into trust is relatively straightforward, according to McCann. “If you have life insurance and it isn’t in trust, simply phone your provider and ask for a trust form.”
McCann said it is important to do this while relatively healthy. “If you are seriously ill and die within seven years, HMRC could argue the policy had a value when you put it into trust and seek to include that in your estate and charge IHT.”
Provided you’re in good health when you put it into trust, there are normally no IHT implications, as in most cases the policy has no value.
Writing a life policy into trust has another advantage, McCann added. “It can also mean a speedier payout as the family won’t need to wait for probate. This can make a huge difference to dependants relying on the money.”
HMRC collected a record £7.5bn in IHT tax last year and the nil-rate bands are frozen until 2028, meaning more families will be caught in the net, McCann said. “This makes it all the more important that loved ones don’t pay inheritance tax on life insurance unnecessarily.”
There are other ways to slash your inheritance tax bill. Read our expert guide to IHT and defend your wealth from HMRC.
