In the context of estate planning - looking at ways to provide for or mitigate a potential inheritance tax ‘IHT’ charge on your estate - one option that is often overlooked is whole-of-life insurance.
How does it work?
It involves taking out a life insurance policy for the whole of your life (i.e. a policy that doesn’t expire after a specific term). You pay a monthly premium and, in exchange, your beneficiaries will receive a tax-free lump sum when you die. That lump sum can then be set against the potential IHT charge on your estate.
Whole of life ‘WoL’ insurance can be particularly effective for those who are in good health at policy inception and/or for those who are income-rich but potentially ‘liquid asset poor’, e.g. someone with a sizeable buy-to-let portfolio and/or a generous final salary pension for example.
The advantages
There’s a lot to like about WoL insurance:
- Immediate cover – Once the policy is put ‘on risk’, you’re immediately covered. There’s no 7-year rule, as is the case with non-exempt gifts for example,
- Low political risk - It’s difficult to see how or why a government could legislate against the use of life insurance in the future, whereas this is always a risk with say Business Relief, trust taxation, etc.
- Fast payout – WoL policies are normally written in trust, which means that any lump-sum payout will sit outside your estate for IHT purposes and will also be made available almost immediately post-death, rather than being tied up in Probate, which can take months (if not, years),
Expanding on the final point, as with any form of insurance, there’s merit to ‘starting early’ here and taking out a policy whilst you’re in good health – that should lead to a relatively low premium. In contrast, if you delay and subsequently have some form of health event before taking out the WoL cover, the cost could be much higher.
Worked example
The worked example below is one where WoL insurance is particularly viable, and also provides an indication of cost:
Bernard and Rose are 65 years old, in good health, and have three children.
They currently have an estate valued at £2m, which includes their main residence (£750k) a BTL portfolio (£1m) and investments (£250k).
They face a potential IHT liability of £400k (40% of the value of their estate above available nil-rate bands totalling £1m).
Their combined rental and pension income totals £80k a year gross or c. £5,750 a month net of tax. This is more than enough to cover their spending needs - they estimate they have around £2k left over each month.
In other words, they have surplus income and a substantial asset base, but most of their assets are tied up in property. They’re reluctant to gift any of their properties as doing so would trigger a sizeable capital gains tax charge, which would otherwise be reset on death.
- On meeting their financial adviser, they decided to take out a new WoL insurance policy with a sum assured of £400k, equivalent to 100% of the potential IHT liability on their estate. As a side note here, it’s likely their estate will increase in value over time, in which case, the WoL policy would no longer be sufficient to cover all of the potential IHT charge. However, it’s a start, and there may be scope to consider other options alongside this (e.g. gifting) and/or taking out additional WoL cover in due course.
- The policy is taken out on a joint life, second death basis, as this is when the IHT liability would apply - there is no IHT to pay when assets are inherited by a surviving spouse,
- The premium, aka. cost is estimated at £602 per month (best quote as of 23/07/2024). That is, Rose and Bernard would pay £602 each month and, in return, their beneficiaries would receive a tax-free lump sum of £400k, payable on the second death,
- The premium and sum assured are guaranteed – i.e. they’ll stay the same throughout. Generally speaking, that would be my preference. You’ll often hear horror stories with ‘reviewable’ plans, which offer lower premiums at the outset, but are typically reviewed after ten years and then every five years thereafter, with scope for sizeable increases, such that the policies may become unaffordable in later life. Guaranteed policies will result in a higher premium at the outset but certainty of cost throughout,
- The policy is written in trust, which means the £400k would not hit the estates of either Rose or Bernard and would be available almost immediately following the second death, with no need to wait on Probate. It could therefore be used to pay some/all of the IHT charge that would fall due, negating the need to ‘fire sell’ assets to meet this.
Comparing the benefit (£400k) with the premium (£602 pm / £7,224 pa), one of Rose and Bernard would need to survive another 55 years (i.e. to age 120) to reach the point at which the total premiums exceeded the guaranteed payout.
Of course, there’s more to it than this, as the premiums could instead be invested where they would benefit from compound growth. If we assume that rather than taking out a WoL insurance product, Rose and Bernard invest the £7,224 a year, with an average 5% return, and that they keep 60% of the resultant profits (as 40% is lost to IHT), the breakeven point would be brought forward to around 35 years from 57, i.e. one of them would need to live to age 100 to be better off (or more precisely, for their kids to be better off) reinvesting the money inside their estates.
Disclaimer: These figures are for illustrative purposes only and do not reflect actual investment returns, which can fluctuate and are not guaranteed.
Drawbacks
In terms of the drawbacks of WoL cover:
- Underwriting at policy outset will cause delays and potentially a higher premium where any health issues are revealed,
- Through WoL cover, IHT is only provided for, not mitigated,
- It’s inflexible – once the policy is started, generally speaking, it cannot be altered,
- The payment of premiums shall be treated as a lifetime gift and therefore could be subject to the ‘7-year rule’ (i.e. the premiums themselves could be liable to IHT should death occur within 7 years). However, these are normally covered by available exemptions. In the example above, the monthly premiums would be fully exempt from IHT under the ‘normal expenditure out of income’ exemption.
- Life Assurance plans typically have no cash in value at any time. If premiums stop, then cover will lapse.
- Premiums are typically costlier than those of term life insurance. Higher premiums may strain your budget, especially in the early years of the policy. So it’s important to consider your financial capabilities before committing to whole life insurance.
Whilst not necessarily a drawback, it’s also important to caveat that all information must be provided accurately and honestly; if not, the cover could become invalid and/or a claim may not be paid.
In reality, WoL can be a ‘tough sell’ as most people recoil at the idea of taking out life insurance in later years, especially at a point where any kids have likely flown the nest and mortgages have been paid off.
However, the maths stack up nicely and it can be a particularly viable option for those who are in good health and ‘starting early’. Also for those who are income rich and liquid asset poor, most commonly BTL landlords or those in receipt of large defined benefit (e.g. final salary) pensions.
In that context, it’s important to redefine WoL cover as a ‘transfer of value’ from one generation to the next, rather than a pure protection policy.
Disclaimer: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. Since I don’t know your specific situation, none of this information should be construed as tax or financial advice. It is not an offer to purchase or sell any particular asset and it does not contain all the information which an investor may require to make an investment decision. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles.
