Using life assurance to eliminate inheritance tax on gifts

By June 3, 2021Tax Planning
Using life assurance to eliminate inheritance tax on gifts

If you are thinking about gifting a large sum of money to loved ones during your lifetime, it is important to realise that the gifts you make could still carry an inheritance tax liability after your death. So, you might want to consider arranging a life assurance policy that will eliminate the risk of leaving behind an unexpected inheritance tax bill.

When Chancellor of the Exchequer Rishi Sunak announced in his March Budget that inheritance tax thresholds would be frozen until 2026, one of the consequences was that inheritance tax and estate planning returned to the top of the agenda for lots of people. We have seen an increase in the number of clients talking to us about the potential inheritance tax liability that could be due on the value of their estate, and we have been pleased to be able to discuss the different estate planning strategies with them – as there are lots of different options available during a person’s lifetime.


What are the current inheritance tax thresholds?

As a reminder, everyone in the UK aged 18 or over has a personal inheritance tax allowance known as the nil-rate band. This nil-rate band currently stands at £325,000. If the value of a person’s estate (money, property and possessions) when they die is below this amount, then there is no inheritance tax to pay. However, if their estate is valued above £325,000, the beneficiaries of the estate will be required to pay inheritance tax at a rate of 40% on the amount over the threshold.

It is also worth noting that if you give your home away to your children or grandchildren in your Will, your estate can also claim the residence nil-rate band, which is another inheritance tax allowance that can increase the value of your estate excluded from inheritance tax to £500,000. However, this allowance is only available provided you leave the home to your direct descendants, and the allowance is reduced if the total value of the estate is more than £2 million.


What are the current rules on gifting?

Gifting money to your family during your lifetime is one of the most popular ways of attempting to reduce an inheritance tax liability. However, in order for a gift to become completely free of an inheritance tax liability, the person who gave the gift must survive for at least seven years from the date when the gift was made. Lifetime gifts of this type are known as potentially exempt transfers. Also known as the ‘seven-year rule’, the inheritance tax bill due on a potentially exempt transfer reduces on a sliding scale for each full year the person who made the gift survives (also commonly referred to as ‘taper relief’); however, no taper relief is available in the first three years after making a gift.

How does this work in practice? Let’s use an example. Frederick gives £200,000 to his daughter. It is a potential exempt transfer, so should Frederick die within three years of having made the gift, Frederick’s daughter would be required to pay inheritance tax at 40% on the value of the gift (£80,000). In year four, the inheritance tax rate drops to 32% (a bill of £64,000), it falls to 24% in year five (a bill of £48,000), 16% (£32,000) in year six, and 8% (£16,000) in the seventh year. After the full seven years have passed, Frederick’s daughter will have no inheritance tax bill to pay, but as those amounts demonstrate, the inheritance tax due on the gift can prove very costly depending on Frederick’s health during those seven years.

Fortunately, there is a way to remove the risk involved with making large gifts and to make sure that the recipient of the gift, like Frederick’s daughter, is not left facing a significant tax bill.


Using a life assurance policy to plan ahead for an inheritance tax bill

One of the most cost-effective ways of avoiding an inheritance tax bill is to set up a life assurance policy that pays out if you were to die, with a sum insured that covers the potential tax liability. In cases where a large gift has been made, or could be made in the future, a ‘gift inter vivos’ policy can be created. Roughly translated, inter vivos means ‘between the living’, and it can be used to pay a lump sum paid in the event of a person’s death during a specific timeframe.

Most users of a gift inter vivos policy arrange for the policy to have a fixed seven-year term, with the amount of cover it provides reducing to match the reduced inheritance tax liability as taper relief starts to take effect. Although the cover reduces, the premium you can expect to pay for this type of assurance policy typically remains fixed for the whole seven years.


Considering the nil-rate band

However, before choosing to set up a gift inter vivos policy, it is important to determine whether the available taper relief will apply in your own particular circumstances. This is because any lifetime gifts made will first be allocated against your nil-rate band when the gift is made. This means that the initial impact of any gift you make, as well as any subsequent gifts, is that your nil-rate band will itself be reduced during those seven years, potentially increasing the inheritance tax liability due on the value of the estate during this time. It is also worth noting that taper relief is applied to the rate of inheritance tax, not to the value of the gift. So, if a gift falls within the nil-rate band, the rate of tax is zero and therefore, taper relief has no effect.

Writing the assurance policy into trust

When we discuss setting up a gift inter vivos policy, we usually recommend that the policy itself is placed into trust. This ensures that the proceeds of a claim made on the policy are not included in the policyholder’s estate, which would otherwise increase the inheritance tax liability. Arranging the policy into trust also means the policy does not get caught up in the probate process, meaning beneficiaries should be able to get the policy proceeds quickly to settle the inheritance tax bill.



One of the most attractive things about gifting money to loved ones – perhaps to help with a house deposit or university fees – is that you’re able to play a part in their future now rather than waiting till you die. But the rules around gifting, especially calculating the liability on lifetime gifts, can be a headache. Using a life assurance policy designed to cover the costs of that liability can really make a difference and is a very effective way of removing the uncertainty that comes with making large gifts.

With more families likely to be caught in the inheritance tax trap – thanks to the frozen inheritance tax allowances – we expect such policies will prove increasingly popular with our clients.


If you are interested in discussing estate planning arrangements or your tax situation with one of our experienced financial planners at FAS, please get in touch here.


This content is for information purposes only. It does not constitute investment advice or financial advice.