Tax relief, inheritance tax, and the difference between life insurance and life assurance

When a UK chancellor announces changes to tax relief in a budget speech, it does not usually generate big headlines. Nor does it create a lasting impression in the minds of voters. But in her inaugural Autumn Budget last October, Chancellor Rachel Reeves announced controversial changes to the UK’s inheritance tax (IHT) regime – most notably, to reliefs and exemptions – that have had an enduring impact, both in the media and in the public consciousness.

The principal rationale for changes to IHT reliefs is, of course, to raise funds for the Treasury. IHT receipts in the UK hit a record high of £7.5bn in 2023/24, an increase of £400m compared to the previous year’s record of £7.1bn. By closing perceived IHT loopholes, that figure is forecast to grow substantially over the course of this parliament. But there is some potentially good news for those who will be most affected: writing a life insurance policy in trust can help to mitigate the impact on their intended beneficiaries.

Budget changes to IHT reliefs affect UK resident and domiciled individuals as well as non-domiciled individuals (non-doms). The biggest single change concerns relief on assets.

Agricultural Property Relief (APR) and Business Property Relief (BPR) were introduced in 1984 and 1976, respectively, to ensure the survival of family farms and other businesses after the owner’s death. In curtailing both reliefs, the government is expected to publish a technical consultation shortly with the reforms planned to take effect from April 2026. Primarily, these are targeted at three distinct groups: farmers, family businesses and non-doms, who live in the UK but are legally domiciled elsewhere.

Currently, APR and BPR are available at 100% or 50% (based on eligibility criteria) with no cap on the total amount of relief. From April 2026, IHT relief for business and agricultural assets will be capped at £1m: a combined cap for both APR and BPR reliefs will apply. A new reduced rate of 20% will be charged above the £1m figure, rather than the standard IHT rate of 40%. The tax will be payable in instalments over 10 years interest-free.

The current 50% rate categories will remain unchanged. Similarly, the current IHT thresholds will remain in place until 2030 and exemptions for transfers between spouses and civil partners will continue to apply.

In addition to the £1m figure, Nil Rate Bands (NRBs) are also applied to IHT. A Nil Rate Band is the amount of an estate that can be passed on to beneficiaries free of IHT. The Residence Nil Rate Band (RNRB), a tax-free allowance for primary residences, is £175,000 per person for estates under £2m. The RNRB remains available only if the house is inherited by direct descendants. In addition, each person has a £325,000 tax-free allowance that can be applied to all types of assets. The Autumn Budget further announced that from 6 April 2027, unused pension savings may be included in an estate for IHT purposes.

These changes have provoked uproar from those who are most affected, not least from furious farmers. Their noisy protests over the proposed changes, including convoys of colourful tractors in Parliament Square, have guaranteed the issue’s continued prominence across national media outlets. Even the normally conservative FT referred to the change as “a shock cap on inheritance tax relief for agricultural assets.”

APR supporters suggest that the argument for the current relief is as valid now as when it was first introduced: to keep the country producing food. Although their story is distinctly less high-profile, numerous small businesses are also adversely affected. Until now, trading businesses could be passed down without incurring IHT. From next April, businesses valued at more than £1m will pay the new 20% rate.

Another group impacted by the IHT changes are the non-doms. In his March 2024 Budget, the then Conservative Chancellor Jeremy Hunt axed their UK’s tax breaks, which allowed approximately 70,000 foreign nationals resident in the UK to avoid paying UK tax on their overseas income and gains.

Reeves’ Autumn Budget largely rubber-stamped Hunt’s proposals, introducing a new four-year foreign income and gains (FIG) regime for individuals who become UK tax resident after ten tax years of non-UK residence. Individuals will have to determine if they are subject to UK taxation based exclusively on their residency status. The IHT regime for non-doms will move to a residence-based system from 6 April 2025. Long-term residents (resident in the UK for at least ten out of the last 20 tax years) will be subject to IHT on their personally owned non-UK assets.

For those who are looking to shield their beneficiaries from a potential IHT liability, or at least to mitigate its impact in part, taking additional life insurance can help to protect them. A life insurance policy in trust avoids IHT because the payout is not considered by HMRC to be part of the policyholder’s estate. Although this is a potentially expensive option, particularly for older policy holders, the net result of the payout being excluded from their estate is very likely to be much more cost effective than paying a large IHT bill directly from it.

A life insurance policy in trust protects assets held within it and ensures that IHT can be paid quickly. It therefore provides a convenient and versatile way in which to protect assets from being eroded by IHT: convenient because it is relatively straightforward to implement and flexible because, with an appropriate bespoke clause, the details can be easily amended or updated as required – e.g. adding new beneficiaries.

Although it does not reduce the overall IHT liability of an individual’s estate, purchasing such a policy can provide beneficiaries with a payout that is specifically designed to cover the anticipated amount of IHT. In doing so, it ensures that they do not have to sell property or other assets in order to meet the bill when it is delivered by HMRC.

So, what are the key elements of establishing a life insurance in trust?

In essence, to create a “life policy in trust” means placing a life insurance policy within a legal trust structure. A professional adviser can assist in the setting up and management of such trusts. In practice, this requires that the policy is not owned by the individual directly, but by trustees who will manage the trust on their behalf.

When choosing how to put a policy into trust, there are two options: a bare trust and a discretionary trust. A bare trust gives beneficiaries an immediate and absolute right to a policy payout. It is typically used for specific beneficiaries, such as children or spouses.

A discretionary trust provides greater flexibility because, based on the needs of the beneficiaries, it enables the trustees to decide how and when the proceeds of the policy are distributed. Discretionary trusts are frequently chosen when greater control over the distribution of funds is needed.

At the outset, trustees need to be appointed and beneficiaries of the trust should be designated. Once the trustees and beneficiaries have been selected by the settlor (the person who creates the trust), the necessary bespoke clauses need to be drafted in order to meet their individual circumstances and wishes.  For example, a bespoke clause will enable the settlor to add or remove beneficiaries in the future. Without such a clause, they will not have the flexibility to do so.

From an IHT perspective, the ultimate objective is that, upon the policyholder’s death, the payout of the life policy can be distributed to designated beneficiaries, with the additional benefit that it will not be considered as part of their taxable estate for IHT purposes. Since the proceeds will go directly to the beneficiaries, rather than HMRC, they are left with the choice of whether or not to use the proceeds in order to pay any IHT that is due.

Given its simplicity and versatility, a life policy in trust provides an excellent solution to mitigate the risk of exposure to IHT. For non-doms who may be intending to leave the UK, it also mitigates against the risk of dying whilst they are still subject to IHT in the UK. Notably, it may help to prevent some farming families from having to sell their Estate to meet IHT requirements. Equally, the same applies to businesses that may have to sell assets.

In broad terms, there are two categories of life insurance: Term life insurance and whole of life plans.

Term life insurance provides coverage for a set period of time (the term), typically ranging between ten and 30 years. A less expensive option, it only pays out if the policyholder dies within the term of the policy and does not accrue any cash value.

Whereas whole-life plans, commonly known as life assurance, provide lifelong coverage. Inevitably, life assurance premiums are higher and usually increase over time. They also include a cash value amount that grows tax-free over time.

Historically, whole-life plans that are taken out to mitigate IHT have required a calculation of the current IHT that is due and then insuring this figure with a policy that is linked to the retail price index (RPI). Any additional growth on the estate that is anticipated above RPI will need to be calculated and allowed for in the amount that is insured.

Term life policies can also be used in relation to IHT exposure in the making of gifts. The Autumn Budget made no changes in the treatment of gifts for IHT purposes: lifetime transfers in the seven years prior to death continue to apply. This means that gifts made more than seven years before death are exempt from IHT, while those made less than seven years before death are captured for IHT.  Those more than three years but less than seven years may be subject to IHT on a tapered basis (commonly referred to as taper relief). No IHT reduction applies if death occurs within three years of a gift being made.

A term policy is therefore useful for a fixed period of up to seven years after an asset is gifted to mitigate against the donor dying within the seven-year window and the gift becoming subject to IHT.

Given the significant changes that have already been announced in relation to IHT reliefs and the potential of further changes ahead, the advantages of placing a life policy in trust are self-evident. It is likely that the number of individuals who choose this option as part of an IHT planning solution will increase. Ultimately, this should enable the families of many farmers and business owners to avoid having to sell parts of their farm or business in order to pay the taxman.

If you need help understanding the changes in personal tax law, contact us by email or call +44(0)3333 231580.