Using a life assurance policy, under trust, to pay an inheritance tax (IHT) liability on death, is a well-trodden path. However, the recent changes in the 2024 Autumn Budget to business property relief, agricultural property relief and pensions mean more people will need to pay IHT, or more than they were expecting to. These changes were slightly amended in the 2025 Budget. A life assurance policy can be a cost-effective solution.

How life insurance can help with inheritance tax

When someone dies, Grant of Probate (or Letters of Administration if the person died intestate) cannot be granted by the Probate Office until HMRC has confirmed that any inheritance tax has been accounted for and paid. This has to be done by the end of the sixth month after the person’s death. For example, if someone dies in January, the IHT must be paid by 31 July.

However, the Personal Representatives (PRs) – usually the executors – typically need access to the deceased’s assets to pay the tax, which they cannot do until the Grant of Probate has been issued. The Direct Payment Scheme sometimes allows PRs to direct the deceased person’s banks to pay funds to HMRC before Grant of Probate. Otherwise the PRs must raise a loan to ‘bridge’ the liability. Any delay in paying the inheritance tax triggers penalty interest charges.

This is where a life assurance policy, held in trust outside the estate of the deceased, can solve the problem. Grant of Probate is not required for the life assurance company to pay out on the policy. It can go straight to the trustees, who then have the cash available to pay the tax within six months, allowing the PRs to obtain Grant of Probate and distribute the estate.

Types of arrangement – whole of life cover and seven-year term policies for gifts

For a married couple or a couple in a civil partnership, leaving their estate to each other typically results in the inheritance tax liability falling due on the second death and not the first. There are some exceptions to this where lifetime gifts have been made. Also, nobody knows when they are going to die. Consequently, any life assurance policy for these circumstances needs to be a whole-of-life, joint-life second-death policy.

For gifts, things are slightly different. The potential inheritance liability only typically lasts for seven years after the date of the gift. There are some exceptions, particularly where a trust has been set in by the deceased during his or her lifetime. In these circumstances, a term assurance policy or a series of short-term policies, are required to protect the potential tax liability caused by the loss of a nil rate band or the tax on a gift. The recipient may need to find this, not the PRs.

Things to consider – pros and cons of the different options

Because the funds are needed before Grant of Probate, the policy must be set up under a suitable trust, ideally from the outset, with a sum assured that matches the tax liability upon death. Also, failing to place the policy into trust typically means that the cash proceeds from the life assurance policy become part of the deceased person’s estate. This makes the problem worse, instead of providing a solution.

Structured carefully, the premiums will reduce the size of the estate and should be exempt gifts, using the ‘gifts from normal income’ exemption. Also, it can be a very cost-effective solution because the total premiums paid during the lives of those assured quite often total less than the liability.

There are several potential downsides, the most important being long-term affordability. For this strategy to work, the policy must continue until the second person has died.

So, for example, when the first spouse dies, their pensions may stop, which may leave the surviving spouse with insufficient income to pay the ongoing premiums. This can result in the policy being cancelled, collapsing the planning and effectively wasting the premiums that were paid up to that point.

Also, if there are health issues, then the premiums can be high, making it an expensive option that may also be unsustainable.

Examples for each option

Here are examples for a non-smoking couple, both aged 75 years, in good health:

• A joint-life second-death, whole-of-life policy, with a sum assured of £325,000, varies between c £6,400 to c£10,300 a year, depending upon which company is chosen and the particular features needed on the policy.
• A joint-life, second-death, level-term policy for seven years, with a sum assured of £130,000 (to cover the tax on the nil rate band) would be approximately £3,900 per annum.
• A joint-life, second-death, gift inter vivos* policy with a seven-year term and a sum assured of £130,000 (to pay the tax on a gift) would be c£1,500 per annum.

*A gift inter vivos policy is a seven-year policy that has a sum assured that takes account of any taper relief on the tax on any gifts made during the deceased’s lifetime.

Importance of advice

Professional advice from a regulated financial advisor or financial planner, who is also a STEP registered Trust and Estate Practitioner (TEP), is vital.

You can find a TEP near you here

Robin Melley TEP, Managing Director, Matrix Capital Financial Planning