The choice between whole-of-life and term insurance for inheritance tax planning comes down to one question: is your IHT liability permanent or time-limited? Whole-of-life insurance guarantees a payout whenever you die. Term insurance covers a fixed period. For most IHT planning, whole-of-life is the appropriate choice — but term cover has an important role for specific scenarios.
When Whole-of-Life Insurance Is the Right Choice
If your estate will exceed the nil-rate band whenever you die — because of property values, investments, or business interests — you need a policy that guarantees a payout regardless of when death occurs. Whole-of-life insurance provides this certainty. The premium is higher than term cover, but the payout is guaranteed. For couples, a joint life second death whole-of-life policy is the most cost-effective structure.
When Term Insurance Is Appropriate
Term insurance is appropriate where the IHT risk is time-limited. The most common scenario is a large lifetime gift — a Potentially Exempt Transfer — where the donor needs to survive seven years for the gift to be fully exempt. A decreasing term policy (gift inter vivos insurance) covers this risk for exactly seven years, then expires. Term cover is also used where the IHT liability is expected to reduce over time as the estate is drawn down.
Key question: Will your estate still exceed the nil-rate band in 20 or 30 years? If yes, whole-of-life is almost certainly the right choice. If the liability is tied to a specific event or time period, term cover may be more cost-effective.
The Trust Requirement for Both
Regardless of whether you choose whole-of-life or term insurance, the policy must be placed in trust to be effective for IHT planning. Without trust placement, the payout joins your estate and is taxed at 40%. With trust placement, it bypasses probate and reaches beneficiaries within weeks — providing the cash to pay HMRC within the six-month deadline.
Premium Funding and the Surplus Income Exemption
Premium payments are treated as gifts to the trust. If they are paid from regular surplus income — and do not affect your standard of living — they qualify for the normal expenditure out of income exemption and are immediately exempt from IHT. This makes whole-of-life premiums particularly tax-efficient when funded from pension income, dividends, or rental income.