Chapter: 2 - Inheritance Tax Mitigation: The Basics

Life Assurance

2.8.1

The classic use of life assurance is to build up, outside the chargeable estate, a fund which can be used to pay at least part of the IHT burden on death.  There is a wide variety of different types of life assurance policy, of which the main ones are described at 10.2.  The ‘traditional’ product for spouse/civil partners or civil partners is the so-called ‘joint lives and survivor’ policy which would pay out on the second death, the spouse/civil partner exemption removing any IHT liability on the first death.  While it is no longer generally possible to obtain Income Tax relief on premiums paid on new policies, the payment of annual premiums within a donor’s financial 'comfort zone’ might be regarded as a sensible investment.  In capital terms property is being extracted from  the ultimate chargeable estate to fund a growth investment, also outside that estate, to meet part of the ultimate liability.  The policy should of course be written in trust, to avoid the policy proceeds falling into the chargeable estate, typically for a class of beneficiaries, and so each premium is a gift which might be protected by either the £3,000 annual exemption or the normal expenditure out of income exemption from IHT.
But for those who are minded to do something a bit more adventurous, there are three particular ‘products’ promoted by the life assurance industry which HMRC have confirmed are effective to avoid both the GWR and POA regimes, even though some benefit or possibility of benefit is retained by the donor/settlor.  Of course, the use of trusts in such cases has been rather curtailed by FA 2006, since no-one will want to incur an immediate IHT liability at 20% of the excess of the chargeable transfer over the nil-rate band threshold.  But such products, namely the gift and loan arrangement, the discounted gift trust and the flexible reversionary trust, remain attractive in principle.  They are described in more detail at 10.5.  It will be important to be able to form a positive view on the likely investment performance of the fund(s) underlying the policy.