Toby Johncox, of Enness Global, a leading high net worth (HNW) mortgage broker and bridging loan broker, and Carlton Crabbe, CEO of Capital for Life, a life insurance and premium financing firm for HNW clients, offer tips about how life insurance can help you protect your hard-earned wealth for yourself and for future generations.
What is life insurance and where does it fit into Inheritance Tax (IHT) planning
It’s important to be aware that most countries in the world charge inheritance tax or wealth tax. However, in places like the Middle East they don’t have inheritance tax so this is something people from that region have to become familiar with when they own properties in places like France, Spain, Portugal and the UK. Wealth tax is incurred on the death of the owner of a property so people need to prepare for that to make sure they can pass on their property to their children or other beneficiaries. The levels of inheritance tax and how it’s charged varies from jurisdiction to jurisdiction but life insurance can be used as a way of planning for wealth tax liability.
If we focus just on UK property, prior to 2017 the usual form of wealth planning for owners of UK property who are non-domiciled, but potentially UK resident, was through an offshore trust or an offshore company. This avoided them having to pay UK inheritance tax on the property. Then in 2017, a new system was introduced called “de-enveloping” which, in summary, meant that properties held in offshore trusts and offshore companies became fully exposed to UK inheritance tax. So life insurance came to the fore over the past few years in particular, because of this need to cover the UK inheritance tax liability, which after all the allowances is charged at 40%. For example, someone with a £10 million pound London property held in an offshore company, or held in personal names, will be liable to an inheritance tax charge of almost £4 million pounds, which is a large chunk of money, and people should plan for how to deal with this.
The general types of life insurance used for IHT planning
Broadly speaking, there are two types of life insurance policy. There’s a term policy, which is fixed for a set amount of time such as 7 years, 10 years or 20 years. You pay the premiums to the insurance company every year, and that gives you or your family a benefit if you should pass away during that term. For example, you might have a 10 year term covering you for £4 million pounds, and it might be costing you, say, £130,000 pounds a year.
The other version is a whole-of-life policy that insures you for the rest of your life no matter when you pass away. A term insurance policy is generally there to make sure that you’re covered for a specific period of time such as the period of a mortgage although there are benefits of having a whole-of-life policy as well.
For estate planning purposes, somebody should typically hold a life insurance policy inside a trust. There are complex tax rules around that. If you’re UK domiciled and UK resident, there is one set of rules. But if you’re a non-domiciled UK resident, there is another set of rules. Everyone should hold a life policy inside a trust because you don’t want the policy paying out, let’s say, £4 million pounds, and then all of a sudden your estate has to pay inheritance tax on the £4 million pounds because the policy is part of your estate as well as the property. That doesn’t solve the problem. So broadly speaking, people should be holding an insurance policy in trust to make sure that the children or the beneficiaries benefit in a tax-efficient way from the policy payout. When a policy is in trust it sits outside of the bureaucratic red tape of any sort of probate so there’s also peace of mind.
Annual tax on enveloped dwellings (ATED)
The other thing to consider is ATED, which is the annual tax on enveloped dwellings. People have the choice of paying that if they wish but, again, that can be expensive. So one of the things worth doing is a tax analysis to determine whether it’s cheaper to pay the ATED or to take out a life insurance policy. On a large £20 million pound plus property, for example, ATED currently is sitting at just below a quarter of a million pounds a year.
In conclusion
It’s fair to say that there have been a number of changes to the rules around how you can hold property in the UK and how tax is charged on it so that’s best left to the tax experts. The one thing you can say about life insurance is it’s non contentious. And it’s unlikely to be legislated against because it provides a lump of cash for the family or the beneficiaries to pay the tax bill. From that perspective, it’s a clean and straightforward solution to planning for payment of an inheritance tax bill.