Thousands of families may have overpaid inheritance tax by an average of £48,000 each because life insurance policies were not placed in a trust, according to experts. Data from HMRC for 2023-24 shows that life insurance policies worth around £850m across 7,020 estates were included in death duty liabilities. Experts warn that these families could have avoided inheritance tax entirely if the policies had been placed in a trust.
£340m in unnecessary death duties
The mistake could have cost families a total of approximately £340m in one year, with each estate incurring an average inheritance tax bill of £48,000. Sean McCann, a chartered financial planner at insurance company NFU Mutual, said: “Many people buy life insurance without advice, so 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 40pc.”
The figures highlight a significant gap in awareness among policyholders. While life insurance is often bought to provide financial security for loved ones, failing to structure it correctly can result in a substantial tax burden that could have been legally avoided.
The importance of trusts
Placing a life insurance policy in a trust removes it from the estate for inheritance tax purposes, meaning the payout can be made without being subject to the 40% tax rate. However, experts caution that the decision to set up a trust should not be taken lightly. Sue Allen, of Chester Rose Financial Planning, said: “The form being simple to fill in doesn’t mean the decision is simple. Once in trust, the arrangement is usually difficult or impossible to unwind, so it is worth taking advice on the right structure for your circumstances before signing anything.”
Trusts come in various forms, each with different rules and implications. For example, a bare trust holds assets in the name of a trustee but gives the beneficiary an immediate right to both the assets and income. Transfers into a bare trust may be exempt from inheritance tax, provided the person making the transfer survives for seven years after the transfer.
Potential pitfalls
While trusts can be an effective way to mitigate inheritance tax, there are potential pitfalls. Mr McCann warned: “However, if you are seriously ill when you put the policy in trust and die within seven years, HMRC could argue that the policy had a value when you put it into trust and seek to include that value in your estate and charge inheritance tax.”
Inheritance tax can also arise in other situations involving trusts, such as when assets are transferred into a trust, when a trust reaches its 10-year anniversary (resulting in a 10-yearly charge), when assets are transferred out of a trust (known as exit charges), or when the trust ends. Additionally, when someone dies and a trust is involved in sorting out their estate, inheritance tax may be due.
Will trusts and future charges
In some cases, individuals may specify in their will that some or all of their assets should be placed into a trust, known as a ‘will trust’. The personal representative of the deceased person is responsible for ensuring the trust is properly set up with all taxes paid, while trustees must ensure inheritance tax is paid on any future charges.
The findings underscore the need for professional advice when dealing with life insurance and estate planning. While setting up a trust can be a straightforward process, the long-term implications mean that individuals should seek guidance to ensure they choose the right structure for their circumstances.
