Inheritance Tax on Life Insurance UK (2026): How to Keep the Payout Out of Your Estate

Whether life insurance is subject to IHT depends entirely on whether the policy is written in trust: (1) LIFE INSURANCE NOT WRITTEN IN TRUST — INCLUDED IN ESTATE: if a life insurance policy pays into the estate (i.e. the policy has no trust and is simply payable to the deceased's estate), the payout is treated like any other estate asset. It is included in the estate at its full payout value and subject to IHT at 40% on amounts above the NRB. Example: £300,000 term assurance policy not written in trust. Policy pays £300,000 into estate. Total estate (house £400,000 + savings £100,000 + policy £300,000) = £800,000. IHT: (£800,000 - £325,000 NRB) × 40% = £190,000. Also: without a trust, the policy payout is part of the probate estate — meaning the executor must obtain a Grant of Probate before the insurer will pay. This delay can leave the family unable to pay the IHT bill (which is due within 6 months of death) or meet immediate expenses; (2) LIFE INSURANCE WRITTEN IN TRUST — EXCLUDED FROM ESTATE: if the policy is written in trust (or assigned to a trust), the policyholder is the settlor, the insurer pays the trustees, and the trustees distribute to the beneficiaries directly. The payout is entirely outside the estate — no IHT, no probate needed. Same example: £300,000 policy in trust pays directly to the surviving spouse or children. Estate for IHT = £500,000 (house £400,000 + savings £100,000). IHT: (£500,000 - £325,000 NRB) × 40% = £70,000. IHT saving: £120,000; (3) HOW COMMON IS THIS MISTAKE: many people do not realise that their life insurance is not written in trust. Term assurance policies, mortgage life insurance, and critical illness cover are often arranged through a financial adviser or bank without anyone mentioning the trust option. The insurer typically offers the option to write in trust when the policy is arranged — it is usually free. After the policy is in force, most insurers will still allow a trust to be declared on request; (4) JOINT LIFE POLICIES: joint life 'first death' policies pay on the first death to the survivor — these are often not in trust because the payout goes to the surviving joint life directly. However, if the survivor later dies with the policy still in force, the payout forms part of their estate. Review with an IFA.

Writing a life insurance policy in trust is a straightforward process that most major insurers offer for free: (1) AT THE TIME OF TAKING OUT THE POLICY: most insurers provide a 'trust form' when the policy is arranged. This is a short document (typically 2-4 pages) that: (a) declares the trust; (b) names the trustees (usually the policyholder + partner + sometimes a third trustee); (c) names the beneficiaries (spouse/civil partner; children; or a discretionary class — usually 'my spouse/civil partner and children' to give flexibility). The policyholder signs the trust deed. Trustees sign. Once completed, the policy proceeds are held in trust for the named beneficiaries; (2) EXISTING POLICIES — RETROSPECTIVE ASSIGNMENT: most insurers will allow a trust to be declared or the policy to be assigned into trust after it was taken out. Contact the insurer or financial adviser and request the trust form for the specific policy. This is free for most term assurance products; (3) TYPES OF TRUST FOR LIFE INSURANCE: (a) Bare trust: the beneficiaries (e.g. 'my spouse') have absolute entitlement. Simple and tax-efficient. No IHT 10-year periodic charges. Cannot be changed once established. Suitable where the beneficiaries are fixed (e.g. surviving spouse is the only beneficiary); (b) Discretionary trust: the trustees have discretion over who receives what from a class of beneficiaries (e.g. 'my spouse and children'). More flexible — if a named beneficiary predeceases, the trustees can distribute to others. However, a discretionary trust may be subject to IHT 10-year periodic charges (0.06% per year on the value above NRB) and exit charges if the trust runs for many years. For a life policy in trust, these charges rarely apply in practice because the payout occurs shortly after death and the trust distributes promptly; (c) Absolute trust (gift inter vivos): used specifically for whole-of-life policies or policies with an investment element; (4) NO PROBATE DELAY: because the payout is outside the estate, the trustees can claim the insurance payout immediately on proof of death — no need to wait for the Grant of Probate. This is particularly valuable when the estate has an IHT bill that must be paid within 6 months; (5) CONSIDER A QUALIFIED TRUST OR PROFESSIONAL TRUSTEE: for large policies or complex family situations, a professionally drafted trust (from an IFA or solicitor) provides better protection than a standard insurer trust form.

A whole-of-life insurance policy written in trust is one of the most widely used IHT planning tools for estates that will have a significant IHT liability: (1) THE CONCEPT: rather than trying to reduce the estate below the IHT threshold (which may not be possible for property owners), the family buys a whole-of-life policy to provide a fund that pays the IHT bill on death. The policy is written in trust — so the payout is outside the estate, reaches the trustees quickly (before probate), and can be used to pay HMRC; (2) HOW IT WORKS: (a) A whole-of-life policy has no fixed end date — it pays out whenever the insured person dies, guaranteed; (b) The sum assured is set to equal the expected IHT liability (or a proportion of it); (c) The policy is written in a suitable trust (discretionary or absolute) with the estate beneficiaries as the trust beneficiaries; (d) On death, the trustees receive the payout promptly. They transfer the funds to HMRC to pay the IHT bill. The estate is then released (probate can proceed with IHT cleared); (3) JOINT LIFE SECOND DEATH: for a married couple, a joint life 'second death' (survivorship) policy is typically more cost-effective — the IHT liability only crystallises on the second death (because everything passes to the surviving spouse exempt of IHT on the first death). The premium is lower than two separate policies; (4) COSTS: whole-of-life premiums are higher than term assurance because the payout is guaranteed (not if you die within a fixed term — but when you die). For a 65-year-old couple with an expected IHT liability of £200,000, premiums might be £200-£400/month depending on health. A financial adviser will calculate the appropriate sum assured and policy structure; (5) PREMIUM PAYMENTS — IHT ON PREMIUMS: if the premiums are paid from income and qualify as normal expenditure out of income (IHTA 1984 s.21), the premium payments themselves are IHT-exempt. This is a significant additional benefit — the premiums are not PETs or CLTs; (6) COMPARISON WITH GIFTING: a whole-of-life policy is an alternative (not a replacement) to reducing the estate through lifetime gifting. Both may be appropriate. Professional financial advice is strongly recommended.

Employer-provided death-in-service and group life benefits are treated differently from personal life insurance: (1) DEATH-IN-SERVICE THROUGH AN EMPLOYER: most employer death-in-service (also called group life) benefits are arranged as excepted group life policies or registered group life schemes. These pay out to a discretionary trust — the employer or pension trustees exercise discretion over who receives the payout (using the employee's expression of wishes as guidance). Because of the trust structure, the payout is entirely outside the estate for IHT. The payout does not form part of the estate and does not require probate; (2) EXPRESSION OF WISHES: it is essential to complete (and regularly update) the employer's expression of wishes form — nominating who should receive the death-in-service payout. The trustees are not legally bound by this nomination, but in practice they almost always follow it. If no expression of wishes is on file, the trustees decide themselves (typically the spouse, then children). Review every time family circumstances change; (3) PENSION DEATH BENEFITS: similar principle — pension lump sum death benefits under a registered pension scheme (DC; AVC; SIPP) are typically written in trust or paid at trustee discretion. Outside the estate for IHT (currently — see note below). IMPORTANT: from April 2027 (Finance Act 2024), unused DC pension funds will be brought into the IHT estate. Review pension nominations urgently; (4) KEYMAN INSURANCE (BUSINESS): a key person policy (insuring a business owner or key employee, with the business as beneficiary) is not part of the personal estate. The payout goes to the business. However, the resulting value in the business may increase the deceased's shareholding value for IHT (though BPR may apply); (5) RELEVANT LIFE POLICY: a single-life policy taken out by an employer for the benefit of an employee and their family. Structured as a discretionary trust — outside the estate for IHT and income tax-efficient (premiums are a business expense).

Critical illness cover (CIC) and income protection are treated differently from life insurance: (1) CRITICAL ILLNESS COVER: a CIC policy pays a lump sum if the insured is diagnosed with a covered serious illness (cancer; heart attack; stroke; etc.) while alive. Since the insured is alive when the payout is made, the CIC payout goes directly to the policyholder — not into an estate. It is not subject to IHT at the time of payment. However: the cash paid by CIC then becomes a personal asset of the policyholder. If it is not spent before death, it forms part of the estate and is subject to IHT. CIC can therefore increase the estate; (2) CIC WRITTEN IN TRUST: writing CIC in trust has limited practical benefit if the intention is to use the money for treatment costs (you need access to the funds). For CIC held on trust for a spouse, the payout could be excluded from the policyholder's estate — but the policy must be carefully structured. An IFA can advise; (3) INCOME PROTECTION: pays regular income if the policyholder cannot work due to illness or injury. The regular income payments are not estate assets — they are income received during life. Once paid, if accumulated as savings, they form part of the estate. Not subject to IHT at the time of payment; (4) CARE ANNUITIES AND LONG-TERM CARE INSURANCE: a 'care fee annuity' (immediate needs annuity) purchased on entry to a care home pays the care provider directly and does not form part of the estate on death. Since the care home fees (not the policyholder) receive the payment, there is no estate asset created. These are sometimes recommended as an IHT planning tool for people entering care; (5) THE BROADER POINT: IHT planning should consider ALL insurance products and their interaction with the estate. An IFA specialising in IHT planning can review the overall insurance and estate position — often identifying policies that should be placed in trust or restructured.