In the recent weeks we have gone through the protection options for Anita and Brad, this will look at their position 15 years on with them both now being 60. We will also look at how they plan to protect their families, with a focus on inheritance tax considerations.
They have successfully grown their business, Funny Bones Physiotherapy Limited, and have made the decision to sell the company before retiring. Throughout their working careers they have implemented protection policies such as personal life insurance, relevant life cover, shareholder protection, income protection, family income benefit, critical illness cover, and in doing so they have protected themselves, their families and the business.
As they sell the business and embark onto the next chapter of their lives, they will need to adjust their protection strategy. Relevant Life cover has played its role but will cease when Anita and Brad sell the business so they will need to adopt an alternative protection strategy.
Whole-of-Life (WOL) policy as an Inheritance Tax (IHT) strategy
WOL is a type of life insurance policy which ensures that, no matter when you die, your beneficiaries will receive a lump sum pay-out from the provider. As long as the premiums are paid and policy terms are met, the cover will last until death occurs.
For instance, Anita is married and on first death the spousal transfer of assets will be exempt from IHT so she is considering implementing a joint-life second death policy for her and her spouse, ensuring on the second death, the policy will pay-out.
The level of cover would be written in trust for the benefit of their children and grandchildren, who will eventually inherit their joint estates and therefore, circumventing probate and IHT consideration on the sum assured. Consequently, the funds paid out to the beneficiaries will usually not only be free from IHT but could provide much needed short-term liquidity for the beneficiaries.
Anita likes to understand her out-goings so it will be best for her choose a guaranteed premium product so that Anita knows how much it is going to cost each month no matter how long her and her spouse live for. They may also want to have the cover increase with inflation to take into account any impact on the value of their estate, this may also prevent having to apply for more cover each year.
Taking the above into account, let us put this into practice and see how WOL cover could protect Anita’s IHT liability.
Accumulation of wealth
Anita and her spouse (Dylan) are age 60, with two adult children and three grandchildren. Following the sale of the business for £2 million net they have paid off all mortgages and debts, and their estate can be summarised as follows:
|Main residence||£1.2 million|
|ISA portfolio Anita||£200,000|
|ISA portfolio Dylan||£200,000|
Currently in the UK for IHT there is a tax threshold, known as the nil rate band (NRB), and below this limit you pay zero tax. For 2022/23 the basic threshold is £325,000. The rate is then usually 40% on anything above this amount. In addition to the NRB individuals may have a residence-nil-rate band (RNRB) of £175,000. This is available when residential property is left to direct descendants. Just like the standard NRB, any unused RNRB on the first death of a married couple has the potential to be transferable to the surviving spouse.
Anita and Dylan will have their NRBs (£325,000 x2 = £650,000) which will not be subject to IHT, However, due to the size of their estate (over £2 million), on the second of them to die, they may not benefit from the RNRB of £175,000 each because it is reduced by £1 for every £2 of value by which an estate exceeds the taper threshold (currently £2 million). In this case, on second death the tapering reduces their RNRB to zero. Their IHT calculation is as follows:
£2,700,000 (ESTATE) - £650,000 (NRB) = £2,050,000 x 40% (IHT) = £820,000
Meaning that Anita and Dylan’s children will have to pay £820,000 inheritance tax which usually needs to be paid within six months (prior to interest charges being applied), before they can inherit their parents’ estate.
Before we look into the benefits of a WOL policy and IHT, lets discuss the negative perceptions associated with this strategy. Firstly, WOL monthly premiums can cost substantially more than term assurance policies and this can be a deterrent. WOL cover becomes more expensive to establish the older an individual gets. With this in mind, it may not be a viable option for 80+ year olds as the providers may not offer them affordable terms.
The premiums may count as potentially exempt transfers (PETs) or chargeable lifetime transfers (CLTs) which could use up some of the NRB but structuring this to be paid out of surplus income can mean the gifts are immediately exempt.
If Anita and Dylan took out a WOL policy for £820,000 to cover the IHT liability it would cost Anita and Dylan £1,161 per month. The table below summarises the amount of premiums paid from age 60 on standard terms and how that looks compared to the original IHT liability:
|Age second death occurred||Premiums paid since establishment at 60 years old||Difference between IHT liability and premiums paid|
|70 years old||£139,320||£680,680|
|80 years old||£278,640||£541,360|
|90 years old||£417,960||£402,040|
|100 years old||£557,280||£262,720|
Guaranteed basis, second death, level cover for two healthy 60-year-olds. Please note that the above figures are for illustrative purposes only.
As the numbers illustrate if they established a WOL policy then Anita and Dylan’s premiums would be significantly less than the IHT bill, even if they lived to 100! Alternatively, if Anita and Dylan choose to do nothing, then as matters stand their beneficiaries will have to pay an approximated £820,000 IHT liability in order to release their estate (although there may be instalment options for illiquid assets such as property).
A WOL wealth succession strategy is a selfless plan, meaning Anita and Dylan will be paying premiums during their lifetime so that their children (and grandchildren) are not left with a substantial burden upon their death. An alternative view is to consider the premiums as an investment for the family that their children (and grandchildren) would benefit from.
For some, this is not seen as a big enough motivator to establish such a strategy, whereas for others it is imperative that they are able to pass on as much of their estate as possible to their loved ones.