Life Insurance and Inheritance Tax

Is life insurance subject to inheritance tax?

By default, yes — a life insurance payout forms part of your estate and can be subject to inheritance tax (IHT) if your total estate exceeds the nil-rate band (currently £325,000, or up to £500,000 with the residence nil-rate band). At 40% tax on the excess, this can significantly reduce the value of the payout your beneficiaries receive.

How to avoid inheritance tax on life insurance

The solution is to write your life insurance in trust. A policy held in trust sits outside your estate — it is not counted when calculating your IHT liability. Your beneficiaries receive the full payout without any IHT deduction.

Writing life insurance in trust to avoid IHT

This is a straightforward process — most insurers provide a free trust deed when you take out a policy. You name your beneficiaries and trustees, sign the deed, and the policy is placed in trust. It takes around 30 minutes and costs nothing.

Using life insurance to pay an inheritance tax bill

Life insurance is also commonly used as an estate planning tool — specifically to provide funds to pay an inheritance tax bill on death. A whole of life policy (sometimes called an estate planning policy) is taken out for the expected IHT liability, written in trust so it pays promptly on death. Executors can use the proceeds to pay HMRC without having to sell estate assets.

What if my estate is below the IHT threshold?

If your estate is well below £325,000, IHT may not be a concern today — but it could become one if your estate grows or if house prices increase. Writing in trust is still recommended for the other benefits: speed (avoiding probate) and control over who receives the money.