How life insurance helps with estate planning and taxes

Estate planning is about more than just deciding who gets what when you pass away. It also involves preparing for the financial responsibilities your heirs might face, including taxes.

Life insurance helps with estate planning by providing a lump sum that can cover inheritance tax, capital gains tax, and other financial obligations.

If you want to protect your estate and make the process easier for your loved ones, life insurance can play a valuable role.

Let’s look at how it works and why it might be a smart addition to your estate plan.

The role of life insurance in estate planning

Estate planning ensures your assets are distributed according to your wishes while minimising financial burdens on your beneficiaries.

Life insurance offers a way to provide liquidity (immediate access to funds) so that your heirs aren’t forced to sell property or other assets to cover expenses.

Here’s how life insurance can help with estate planning:

• Covering life insurance inheritance tax (IHT) liabilities.
• Paying capital gains tax on inherited property.
• Preventing heirs from needing to sell family assets.
• Providing financial security for dependents.

If you haven’t yet created an estate plan, writing your first will is a good starting point. A well-structured plan, including a will and life insurance, can protect your wealth and make life easier for your loved ones.

How life insurance can cover inheritance tax

In the UK, inheritance tax is charged at 40% on the portion of an estate that exceeds £325,000 (or £650,000 for married couples). If your estate includes property, savings, or investments above this threshold, your beneficiaries could face a large tax bill before they can access their inheritance.

Life insurance can provide the funds to cover this cost, preventing your heirs from needing to use their own money or sell assets to pay the tax.

Writing your policy in trust

For life insurance to be used effectively in estate planning, it’s best to write the policy in trust. This means the payout goes directly to your chosen beneficiaries rather than forming part of your estate, which could otherwise increase the taxable amount.

If your policy isn’t written in trust, the payout itself may be subject to inheritance tax, reducing the amount available to cover other taxes and legal expenses.

Using life insurance for capital gains tax on property

If you leave a property to your heirs, they may be liable for capital gains tax (CGT) if they later sell it at a profit. While CGT is usually not applied when inheriting property, it does apply if the property is sold for more than its value at the time of inheritance.

Life insurance can help by:

• Providing funds to cover CGT if your beneficiaries plan to sell the property.
• Reducing the need for heirs to sell other assets to pay taxes.
• Offering financial flexibility to keep a property in the family rather than selling it immediately.

For homeowners, mortgage life insurance coverage is also worth considering. This ensures that outstanding mortgage debts are cleared upon death, preventing financial strain on surviving family members.

Choosing the right life insurance for estate planning

There are different types of life insurance, but not all are suited for estate planning. The two main options are:

Whole life insurance

Whole life insurance provides lifelong cover and guarantees a payout, making it ideal for covering inheritance tax and estate costs.

Since it doesn’t expire as long as life insurance premiums are paid, it ensures funds are available when needed.

Term life insurance

Term life insurance lasts for a set number of years and only pays out if you pass away within the term.

It can be useful if you only need cover for a specific period, such as while repaying a mortgage or raising children. However, it may not be the best option for covering inheritance tax, as the policy might expire before it’s needed.

If you’re over 60 and considering life insurance as part of your estate plan, over 60s life insurance policies are tailored to provide guaranteed payouts, regardless of health conditions.

Keeping your estate plan up to date

As your financial situation changes, so should your estate plan. If you purchase property, receive an inheritance, or experience major life events like marriage or divorce, you should consider updating your will to reflect these changes.

Failing to update your estate plan could leave your family with unexpected complications, including tax liabilities that could have been avoided with better planning.

Final thoughts

Life insurance helps with estate planning by providing funds to cover inheritance tax, capital gains tax, and other expenses, preventing financial strain on your heirs. Choosing the right policy, writing it in trust, and keeping your estate plan updated can all help protect your assets for future generations.

If you’re considering adding life insurance to your estate plan, comparing life insurance providers can help you find the best policy for your needs. Planning ahead now can make a huge difference for your loved ones later.