Inheritance tax is charged at 40% on the value of an estate above the nil-rate band of £325,000. For many families, the bulk of that estate is tied up in property — an asset that cannot be liquidated quickly. Life insurance, structured correctly and placed in trust, provides the cash to pay HMRC within the six-month deadline without forcing a sale of the family home.
The Liquidity Problem
Most estates in England and Wales are asset-rich but cash-poor. A family home worth £600,000 may sit alongside only £20,000 in savings. When HMRC demands £110,000 in inheritance tax within six months of death, beneficiaries face a stark choice: sell quickly at a discount, borrow at high cost, or use life insurance proceeds to pay the bill. Life insurance is almost always the most cost-effective solution.
Why the Policy Must Be in Trust
This is the critical step that most people overlook. A life insurance policy that pays out to your estate is included in the estate valuation and taxed at 40%. A policy placed in trust pays out directly to the beneficiaries — bypassing probate entirely and arriving within weeks of death being registered. Without trust placement, the policy payout can itself generate an IHT liability.
Example: A £200,000 whole-of-life policy not in trust adds £200,000 to the estate. If the estate is above the nil-rate band, 40% of that £200,000 — £80,000 — goes to HMRC. Beneficiaries receive £120,000, not £200,000. With a trust, the full £200,000 passes tax-free.
Whole-of-Life vs Term Insurance
Whole-of-life insurance guarantees a payout whenever you die — making it ideal for covering a permanent IHT liability. Term insurance covers a fixed period and is cheaper, but the policy may expire before death. For IHT planning, whole-of-life is generally preferred unless you are covering a specific time-limited risk, such as the seven-year PET period on a large gift.