How life insurance can protect against IHT liability
© Adobe Stock Many farmers are investigating life insurance in the light of the cut in inheritance tax (IHT) relief which is due to take effect from April 2026. Advisers stress that every situation needs careful assessment and the solution for one family will be different to another.
Similar to pensions, the sooner life cover is started, generally the better – and in the case of life cover, the cheaper it is assuming reasonable health.
See also: Budget highlights need for inheritance document housekeeping
Premiums increase with age, as does the likelihood of medical complications, which in turn will increase the cost of cover.
Cost versus risk
Assessing the affordability of cover against the IHT risk needs to be part of a clear business plan and strategy, with supporting budgets, says Guy Coggrave, managing director of consultant GSC Grays.
It is quite common for farmers to have some life cover as a condition of bank lending, he says, and while this is unlikely to cater for a potential IHT liability, the details of any such cover should be checked for length and level of cover.
For most people life cover is affordable when weighed against the IHT risk, says Guy, who sees a mix of cover as the solution in many cases.
“For example, you might want £3m of cover overall and take £2m of term cover up to the age of 70, assuming you want to transfer the assets by that age and allowing for any taper which reduces the liability as the seven year period progresses.
“This could sit alongside £1m whole of life cover to protect your liability on assets you wish to retain or to provide a fund on death for other family members.
“Once you get to the mid-eighties in age, it becomes very expensive but it is one less risk to manage.”
If assets are being transferred by a valid will to a spouse or civil partner on death, no IHT will be due, so one option here is to insure the second death only.
“This will reduce the cost of the premium, compared with insuring both lives, but it will not halve the price,” says Guy.
He stresses that it is important to consider covering the life of the younger generation too, those who have been handed assets.
The proceeds of life cover can also help with inheritance planning for those not involved in the farming business or who will not inherit farming assets, especially if whole-of-life cover is taken and potentially exempt transfers have completed, he suggests.
Potentially exempt transfers
Potentially exempt transfers (Pets) are gifts made during lifetime. No IHT is due on those gifts if the donor survives seven years from the date of the gift.
Holly Hill is associate director at broker John Lamb Hill Oldridge (JLHO), handling cover for liabilities of £1m-plus.
The common approach is to use term insurance on either a single-life or joint-life for married couples and civil partners using the ability to transfer assets to their spouse or partner on death, says Holly.
“We have also been seeing a huge amount of gifting of assets recently,” she says.
“The potential IHT liability created by a death within seven years of a gift can be protected by what is termed gift inter-vivos-cover.”
Holly gives the example of a £2.5m gift carrying £1m of tapering liability to IHT over seven years, which can be covered for less than 1% of the liability up to age 65, assuming reasonable health, and at 5.7% for those gifting at age 80.
“This way you can make the gift a closed deal and not have to worry about the potential IHT impact.”
Lifestyle and medical history
The cost of life insurance is based on the situation at the time the cover is taken out, in terms of medical history, lifestyle and occupation.
“What is true at the time of application is what is relevant. If your lifestyle improves afterwards some insurers will allow you to reduce your premiums,” says Holly.
“For example, if you are a non-smoker when you take out the policy but then become a smoker, this will not increase the premium.
“However, if you are a smoker at the time of taking out cover, then this is likely to double the cost of the cover compared with if you were a non-smoker.”
Smoking for insurance purposes covers using any nicotine product, including vapes. If recreational drugs have been used in the past five years this is likely lead to a postponement of cover until five years have passed since the last use.
Not all hazardous activities will be a problem for obtaining life insurance, says Holly, but skiing off piste without a guide, wreck diving, mountaineering, solo flying and horse racing would require further investigation.
Arranging life cover will usually involve a medical report, which can take several weeks to obtain, from a GP.
In the case of JLHO, the firm underwrites the medical risk in house, arranging a medical report, which is then put out to the whole UK market, avoiding the need for multiple reports.
Types of life insurance
There are three main types of cover:
Whole of life
This simply pays out on death. Whole-of-life insurance can be offered on a reviewable or guaranteed-premium basis.
Term cover
This type of cover is limited in length, and can be either on a level basis, where the amount covered is fixed, or indexed either by tracking the RPI or at a fixed annual rate.
Gift cover
This is designed to protect the seven-year period in which assets that are handed over are known as potentially exempt transfers.
If the donor dies in years one to three after making the gift, then the full inheritance tax is due.
From year three to four the liability tapers to 32% and reduces in steps each year to 8% in year six to seven.
All policy types can be cancelled at any time without loss other than the premiums already paid.
Divorce and life cover
Where a joint life policy is taken out for a married or civil partnership couple who then divorce or separate, the cover no longer matches the liability, points out Holly.
“This can be catered for by having an appropriate separation clause.
“This clause allows joint-life cover to be split into two single life policies along the terms of a divorce settlement so that each party retains enough insurance on their share of the assets.
“There is no need for further medical underwriting at this stage.
“If there is no separation clause then the policy is defunct and you need to buy new single life cover and complete new medical underwriting.”
Warning on reviewable premiums
Whole-of-life policies can be on the basis of either guaranteed or reviewable premiums.
While the reviewable premium option will be cheaper initially, premiums can be ramped up severely at review, warns William Godsave, head of financial planning at wealth management adviser Credo.
“Many clients who took out reviewable whole of life policies in the past did not fully appreciate the potential for the significant increases in premiums at the review dates.
“It is therefore essential that clients consider carefully the long-term implications and effectiveness of these policies on their affordability and objectives,” he says.
He advises that taking out policies of different types to cover different timescales and levels of risk can be the most cost effective solution.
Broker disclosure
In good time and before a contract is concluded, brokers must disclose any payment they receive in relation to that insurance contract, whether that is a commission of any kind, a fee paid directly by the customer or any other type of remuneration.
Accountant report shows challenge of covering the risk
Sam Kirkham is a partner with accountant Albert Goodman and spokesperson for the Rural Accountancy Group (RAG), which comprises 10 accountancy firms across England and Scotland.
The RAG has put together a report urging the government to rethink its inheritance tax relief plans.
As well as offering solutions to meet the government’s aim of raising tax, the report makes several suggestions as to how farms could be helped.
These include providing income tax relief for life insurance premiums, which are not allowed as a business expense except in a limited way for companies.
The report includes more than 20 real-life case studies, in some of which life insurance is unaffordable or unavailable because of the age and or health status of those involved.
“We’re talking to a lot of farmers about insurance,” says Sam. “It’s really important for the younger generation to be covered, where we can’t plan succession yet but you still have to plan for unexpected events.”
Level term cover is the most cost effective in the years leading up to implementing a succession plan, she says.
Her further advice includes:
- It is essential for policies to be written in trust, so that the proceeds remain outside an individual’s estate for IHT
- Make sure that what is in the will matches what the life insurance policy says in terms of who the policy proceeds should go to and when the IHT liability arises
- Bank accounts are often frozen on death, so it’s important to ensure that direct debits such as for life insurance for other individuals. continue to be paid. Keep a list of these in the farm office, or with the wills, so that the executors can quickly see what essential payments need to be made.