Many of my clients hate inheritance tax, but accept that it is a necessity for society. Inheritance tax is currently the only wealth tax we have in the UK, so it is the only shield – however flawed – we have against the unchecked accumulation of wealth into the hands of only a very few families. As such, many people do not want to use the loopholes and allowances available to them in full because they believe they have a moral duty to pay the tax.
Luckily there’s a solution. At the moment, a whole of life policy can be set up to cover the projected tax. This allows your heirs to inherit your full estate (less any premiums paid) and still have the inheritance tax paid upon your death.
This sounds too good to be true, or like there must be a hidden cost, so what is that cost?
The reality is that the “hidden cost” is paid by people who take out policies like this and allow them to lapse. In those cases, insurers keep the premiums and pay nothing out, meaning the money is lost. Under such circumstances, the client loses 100% of the premiums they have paid, much like you lose the premiums paid for car insurance each year even if you make no claims.
So what might it cost?
In this example, let’s consider Mr and Mrs Apple, who are both 50 and have a combined estate of £10 million. This is well over the point at which the residence Nil-Rate Band is withdrawn, so the assumption is that on death they will owe some £3.7 million in tax unless they take action to reduce that figure. On discussion, they decide that they do not want to reduce the amount, instead they want to contribute what they feel is their rightful contribution to society, meaning they are not going to make use of gifts, loans or exempt assets which could reduce or eliminate this amount.
Instead they decide that they want to take out a policy which matches their wills, which stipulate that the estate should pass in its entirety to the survivor and then to children. This policy costs a shade under £25,000 assuming good health and non-smoker status. This sounds like a reasonable deal, but what does it mean?
To put it into more readily-understandable terms, I have made a calculator to turn the premiums into rates of return based on how much longer the clients live. Obviously we don’t know this timescale, so I have had to include multiple possible options, ranging from the very pessimistic to the very optimistic.
What do these figures mean? I have found over the years that clients like to look at this type of policy as though it were an investment. In other words, the actual underlying instrument is largely irrelevant, all that matters is the amount of money in and the amount of money out, that way someone can decide whether it represents good value.
In this instance, I have not included the 10 year option, as that seems unduly pessimistic for a couple who are only 50!
Here the figures are very appealing. Even if the longer-term survivor lives to age 100, the “black box” returns the equivalent of 3.81% interest on the full amount. This is a little under cash rates available at the moment, but it is full protected by the Financial Services Compensation Scheme and is not subject to income tax or inheritance tax if set up correctly.
The true beauty of this type of policy is that it acts as a hedge against dying early. It gives clients certainty that even if they do nothing else, their inheritance tax bill will be paid and their heirs will receive a sizeable net inheritance.
Obviously the downsides are the commitment to pay premiums for the rest of the client’s life and the fact that this type of policy does not offer any form of benefit to the policyholder personally, other than the comfort of letting them know that the next generation will be looked after.
This is only one facet of inheritance tax planning, but it is well suited to those who believe that paying inheritance tax is their moral duty but begrudge the impact it will have on their family.
If you would like to discuss this in more depth, please get in touch and I can talk to you about how you can set up something like this for yourself.