Using a Whole of Life plan when inheritance tax planning

For a single person this would normally be a single life plan on their own life written under trust for the benefit of whoever will inherit your client’s estate.  For a couple who are married or in a civil partnership, who are leaving everything to each other on first death, this would be a joint life second death policy, again written under trust for the benefit of who will eventually inherit their joint estates.

In both of these cases you would probably choose a guaranteed premium product so that the clients know how much it’s going to cost them each month no matter how long they live. Although they may also want to have the cover increase with inflation in order to take account of any impact on the value of their estate because of this without having to apply for more cover each year.

You may also have some clients who want to pass on part of their estate whilst they are still alive taking advantage of the exemptions that are available for gifts. Or, they may be looking to change where their investments are held to take advantage of the various reliefs that are available such as business property relief. Both of these strategies or a combination of both can be used to reduce the amount of inheritance tax that is eventually payable. But both of these take time to get the full effect of the reduction in tax, so some cover may still be needed at least until the full benefits are realised. Circumstances may also change and so some flexibility in the amount of cover and how long it lasts should be built in to any arrangement and any arrangement should also be cost effective. A whole of life plan with reviewable premiums could be an ideal way for your client to leave a lump sum for loved ones to pay the IHT liability where there are strategies in place to reduce that liability over time.

How this could work in practice

Mary is recently widowed and now having been left everything by her husband has an estate of £1.5m.  This consists of her house, some investments including an ISA and some cash. Having not made any previous gifts she’s able to take advantage of both her own and her husband’s nil rate band as well as the full amount of both of their residence nil rate bands giving at total nil rate band of £1m.  She therefore has a current IHT liability of £200,000.

Mary intends to make gifts to her 2 grandchildren in future when they leave university.  She’s also in the process of gradually changing some of her ISA investment to invest in AIM shares in order to diversify the portfolio and hopefully provide a better return.  Both of these will reduce her liability to IHT over time but in the meantime she wants a cost effective way of making sure there’s money available to pay this if she dies before this can happen.

When Mary went to see her adviser, they recommended that Mary take out a Pegasus Whole of Life plan with reviewable premiums with an amount of cover of £200,000. Mary is 60, a non-smoker and in good health so her initial premium is £100.53. Writing a whole of life plan on a reviewable premium basis provides the highest benefit amount for the lowest initial premium. Mary’s premium will remain unchanged for the first 10 years, but then will be reviewed every five years thereafter. Premiums will increase significantly at each review, however in the periods between these reviews there may be an opportunity to reduce the sum assured on the plan as her liability changes over time, which would reduce the impact on the premium.

Three years later Mary makes a gift of £20,000 to her eldest grandchild following their graduation from university.  As she has made no other gifts the first £6,000 of this is immediately exempt under the annual exemption as she can use last year’s exemption as well as this year’s.  The remaining £14,000 is a potentially exempt transfer (PET) which will be taken into account in calculating Mary’s IHT liability for the next 7 years.  There will be no IHT on the PET itself as this falls within Mary’s nil rate band and there is no immediate effect on her IHT liability either.  She also transfers £50,000 of her ISA savings into a fund investing in AIM shares which will qualify for business property relief.  There is no immediate effect on her liability but the value of that investment will fall outside of her IHT liability calculation after 2 years, which is the qualifying period for business property relief.

Two years later Mary makes a further gift of £20,000 to her youngest grandchild following their graduation. As she has made no other gifts in the last two years she can again use her last 2 year’s annual exemptions so the first £6,000 is exempt and only £14,000 of the gift is a PET which will be brought back into the calculation if Mary dies within the next 7 years. She also transfers a further £150,000 of her ISA into the fund investing in AIM shares which will qualify for business property relief in two year’s time.

At the 10-year anniversary of taking out her Pegasus Whole of Life plan Mary’s premium is reviewed. To keep her initial amount of cover her premium will increase to £300.31. But let’s look at what Mary’s liability for IHT is now.

The value of her home and savings has increased to £1.7m. Assuming the nil rate band and residential nil rate bands have remained the same she still has a total nil rate band of £1m.  The PET of £14,000 to her eldest grandchild was made 7 years ago so this no longer needs to be taken into account. The PET to her youngest grandchild was made less than 7 years ago this needs to be added into the calculation and as it falls within her nil rate band taper relief is not available.  Her AIM shares ISA is now worth £300,000 and as she has held this for more than 2 years all of this qualifies for business property relief at 100%.  Her taxable estate is therefore now £414,000 (£1,700,000 + £14,000 - £300,000 - £1,000,000) and her IHT liability is now £165,600 (£414,000 x 40%). So although the total value of Mary’s estate has increased her liability has reduced and could be reduced further with careful and timely planning. Mary could therefore reduce her amount of cover to this amount which would mean her premium will now be £257.10.

Some important things to consider

These plans can also be written on a guaranteed premium basis. With a guaranteed premium, the premium is calculated at the start of your client’s plan and won’t change unless the amount of cover changes.  This may be more suitable for someone who has no ability or no desire to reduce their liability or just wants the certainty of how much their cover will cost throughout the rest of their life.

It’s also important to make sure the plan is written under trust.  Often providers have a tool to help you identify the right trust structure and form for your client.  Without a trust the policy would be part of your client’s estate adding to the inheritance tax problem. Your client should also think about who the trustees should be. A trustee should be someone your client trusts to carry out their obligations for example a partner, other family member, or friend. Trustees must carry out certain obligations and duties so the position shouldn’t be taken lightly. Your client should therefore ensure that the trustees are fully aware of their intentions so that they can carry them through.

Understanding the effects of any inheritance tax planning and choosing the right policy and putting it in place in the right way to run alongside those is a key part of giving your client the best chance of their plans coming to fruition.