Policies for Life – Make Sure They Pay

Insurance is an often neglected aspect of financial planning, especially when it comes to thinking about your estate.

There are several options available for reducing Inheritance Tax (IHT), for example, making gifts, placing money in trust, or investing in business assets.

Insurance policies can also have a place in your estate plan. While an insurance payout won’t reduce your IHT bill, it can ring-fence a sum to pay the tax so that the assets in your estate can pass to your loved ones with minimal complications.

So are whole of life policies good value?

Whole of Life Policies

A whole of life policy works as follows:

•         You pay monthly premiums, and in return, the insurer will pay out a lump sum on death, whenever this occurs.
•         The premium will depend on your lifestyle and medical history. If you have had a serious medical condition, you may not be eligible for cover.
•         Premiums can be guaranteed or reviewable. Reviewable plans will start out cheaper, but can work out more expensive over the lifetime of the plan.
•         Some policies have an investment element. The performance of this investment can mean that your future premiums will be higher or lower.
•         Policies can be set up on a single or joint basis. Joint policies normally pay out on second death.
•         The policy can be placed in trust, and it is usually advisable to do this. This means that the policy benefits will be outside your estate and free of IHT.

Advantages

The benefits of a whole of life policy are:

•         Unlike a term assurance policy, you can be sure that a whole of life plan will pay out at some point, providing you keep up with the premiums.
•         A whole of life policy, placed in trust can offer a useful way of transferring wealth outside your estate.
•         This is not only efficient from an IHT perspective, but it also means that plan benefits bypass probate procedures and reach your beneficiaries more quickly.
•      The regular premiums may qualify for immediate exemption from your estate, either under the regular gifting allowance (£3,000 per person, per tax year), or the ‘gifts from surplus income’ exemption.
•         It is a fairly ‘painless’ way of mitigating IHT as it doesn’t require you to give away any of your existing capital, or place money in high risk investments. 

Disadvantages

There are a few potential pitfalls with whole of life policies:

•         Guaranteed premiums will be very expensive, and could take up a considerable amount of your monthly budget.
•         Reviewable premiums can increase substantially in five or ten years, and at regular intervals thereafter. It can be difficult to work out what the total plan costs might be.
•         You may end up paying out more than your estate receives in return.
•         If you cancel the plan when the premiums become unaffordable, you will usually receive nothing in exchange for the premiums already paid.
•         Whole of life policies may only be a realistic option if you are in good health.
•         Trusts add another layer of administration and complication. If you do not set up the trust correctly, the policy benefits will form part of your estate.
•         Your trustees will also have to manage the trust’s funds on your death, and may need to take tax, legal, and investment advice.

When Whole of Life Plans Can Be Useful

Whole of life plans can be useful in the following situations:

•         If you would like your beneficiaries to receive a lump sum outside your estate.
•         If you have a substantial surplus income. This means that the premiums will be affordable, and usually immediately outside your estate.
•         If you have a high income, but limited assets (for example, if your main source of retirement income is a final salary pension scheme) and you would like to create a legacy to pass on.
•         If you do not want to give money away, place it in trust, or invest in higher risk business assets. Or, if you have already done all those things and still have an IHT liability to mitigate.

What Should You Watch Out For?

The main issues to be aware of are:

•          It’s important to be mindful of the costs, and to get a realistic indication of the total premiums paid versus the eventual payout. You should receive an illustration from the insurer that can help with this.
•          Underwriting a plan can take weeks, or even months, and can involve questionnaires, medical examinations, and blood tests.
•          Over 50s plans (as advertised on daytime TV) offer a quick and simple route to setting up a whole of life plan. These usually pay out a relatively small benefit, but no underwriting is required. The plans are priced accordingly, which means that healthy people with a long life expectancy will be subsidising those who die in the early years. If you are in good health, these plans are unlikely to offer value for money.
•          If you take out your whole of life plan for IHT purposes, the trust will be a key component. However, it is not mandatory and the insurer may not follow up with you if the trust deed is not received or if it is not completed correctly. It’s worth checking with the plan provider that the trust has been received and correctly applied.
•          Other IHT planning solutions may be a better fit for your circumstances, or could be worth considering alongside a whole of life policy.

If you have an IHT liability, it is usually worth seeking advice on the best way to mitigate this. Insurance plans can form part of the solution, but they are not a ‘quick fix’ or easy answer.

Please do no hesitate to contact a member of the team to find out more about your protection and estate planning options.