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Understanding inheritance tax and life insurance

LifeSearch author Katie Crook-Davies
4 min read

by Katie Crook-Davies, Protection Writer

See author bio

Katie works with insurers and distributors to make protection propositions more accessible, pricing more transparent and marketing messages more simple.See author bio

Guide last reviewed 10 Oct 2023

They say that nothing in life is certain except death and taxes, and inheritance tax really hammers this home, because it’s basically a death tax! But don’t worry, not everyone has to pay inheritance tax and there are things you can do now to make sure that your family isn’t left with an unwanted tax bill. We explain all in this guide!

What is inheritance tax?
What about inheritance tax for married couples or civil partners?
What is the inheritance tax home allowance?
Inheritance tax and life insurance

What is inheritance tax?

First thing’s first - how does inheritance tax work? Inheritance tax is tax that’s paid when you pass on assets when you die. That could be property, money, investments or material possessions like a car or jewellery - basically anything that you own and is said to form part of your estate.

So, who has to pay inheritance tax? This type of tax is only due if an estate, remember that’s someone’s property, money and possessions, is worth more than £325,000. This figure is called the inheritance tax nil-rate band, because anything below this figure isn’t taxed. We’ll call it an inheritance tax allowance, because that’s simpler. Anything above this figure is taxed at a whopping 40%, or 36% if you decide to donate to a charity in your will.

What about inheritance tax for married couples or civil partners?

The good news is that if you’re in a married couple or a civil partnership, and you pass away, your spouse or partner can inherit all of your assets without paying any inheritance tax. In addition, both of your inheritance tax allowances get combined.

It gets a little confusing, but let’s explain with an example. Say you and your spouse have an estate worth £500,000 and one of you dies, the surviving spouse will inherit the full estate and pay no inheritance tax. Plus the unused £325,000 inheritance tax allowance of the partner who passed away also passes to the surviving partner, to basically double their inheritance tax allowance to £650,000. This means that no inheritance tax will be due when the surviving partner dies, because the estate is worth less than £650,000.

What is the inheritance tax home allowance?

There’s even better news if you own a property which you’d like to give to your children (including adopted, foster or stepchildren) or grandchildren when you pass away, there is an additional £175,000 inheritance tax home allowance, known as the main residence nil-rate band that was introduced by the government in 2017.

So, on top of the £325,000 we mentioned earlier you can potentially pass on £500,000 to your loved ones without any inheritance tax being paid. And you guessed it, this amount doubles for couples, so the total allowance if you’re married or in a civil partnership is up to £1,000,000 (£325,000 x 2 plus £175,000 x 2) - that’s £1,000,000 that could pass to your children completely tax-free! It’s worth knowing that to get this full additional allowance you must have lived in the property, so it can’t be buy-to-let and your total estate must be worth less than £2,000,000.

Here’s an example: Say you and your spouse have an estate worth £1.5m including the property you both live in. You have a combined inheritance tax allowance of £1m including the property allowance. When you both die and pass on your estate to your children, £200,000 in inheritance tax will be due, which is 40% of the amount above your allowance (40% of £500,000).

Inheritance tax can get pretty complicated*, so if you have further questions, why not give us a call on 0800 316 7253. We're here Monday – Friday 8am – 8pm, Saturdays from 9am – 2pm and Sundays 10am - 3:30pm, and would love to help.

* We strongly recommend seeking independent financial advice, to calculate your total estate value and liabilities wherever possible.

Inheritance tax and life insurance

You may be thinking that £1,000,000 is a huge amount of money and that you’ll never go over that amount and need to pay inheritance tax, but be careful, because your estate includes everything from your savings, to your investments, dividends and your home. All of these things can really add up. If you’re worried about inheritance tax reducing the amount passed on to your loved ones, it might be time to think about whole of life insurance, an insurance policy which can be used to cover any inheritance tax due, paying out a benefit to match the amount of tax owed.

It’s worth bearing in mind that the payout from a whole of life insurance policy can also form part of your estate, which means that it could incur an inheritance tax charge, unless you put your policy into trust. This can be done when you apply for your cover and will mean that the insurance benefits paid are protected from inheritance tax - so will go directly to your loved ones. Find out more about trusts in our article on Life Insurance Trusts.

We are knowledgeable when it comes to all things tax and trusts**, and can work with you to build a protection solution that’s personalised to your situation and specific needs.

**We’ll help where we can with Trust and IHT advice, but may recommend that you seek independent expert financial advice dependent on your situation.

Compare & buy life cover quotes online - then put your policy into trust for free

We encourage all of our customers to place policies into trust wherever applicable. If you buy a policy that can be placed into trust we can help you do just that.

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LifeSearch author Katie Crook-Davies
Katie Crook-Davies Protection Writer
Katie is an independent insurance consultant who is passionate about protection and wants to share that passion with others through engaging marketing content. She hopes that one day people will get as excited about protecting themselves and their loved ones, as she does!
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