You can escape inheritance tax by completing one easy form – average saving £210,000

Inheritance tax explained by Interactive Investor expert

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Reducing your family’s exposure to this 40 percent tax is more important than ever, following Chancellor Rishi Sunak’s decision to freeze the inheritance tax (IHT) threshold for five years. IHT bills could soar as a result, but careful planning could radically cut the cost.

Many don’t realise that if they take out a life insurance policy to protect their family, this will count as part of their estate when they die.

Tom Skinner, founder of Barnaby Cecil Financial Planning, said parents often buy life cover worth hundreds of thousands of pounds to protect dependents such as children. “The IHT threshold has been frozen at £325,000 since 2009, so many of these life policies could incur the 40 percent tax.”

Any life insurance payout will be added to your other assets, including property, shares, Isas and so on, when calculating the total value of your estate on death.

So even if your life insurance policy is worth less than £325,000, it could still push you into the danger zone.

Thousands get hit by the hated “death tax” every year as a result. Yet many could have avoided paying a penny.

One in four estates that incur an IHT bill include money from life insurance policies, HMRC figures show.

Given that around 22,000 estates pay inheritance tax in a typical year, that means 6,000 families a year could be throwing money away.

Families paid more than £280 million unnecessarily by failing to do so in the 2018/19 tax year alone, said Sean McCann, chartered financial planner at NFU Mutual.

Yet it is simple to remove a life policy from your estate. “If life policies are written into trust, they will not normally form part of the deceased’s estate and would therefore not be liable for inheritance tax.”

McCann said putting life insurance policies into trust is relatively straightforward but could save families huge sums.

Insurance companies should automatically send a trust form when you take out a life policy, but many people never get round to filling it in.

Their loved ones may regret that oversight later.

McCann said putting life insurance policies into trust is relatively straightforward but added: “Many people buy life cover without advice, so aren’t aware that if they don’t put the policy in trust it’s included in their estate and could end up being taxed at 40 percent on death.”

He advised: “If you have life insurance and it isn’t in trust, phone your insurer and ask for a trust form.”

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Trusts work best for people who are relatively young or in good health, due to the inheritance tax seven-year rule.

This states that all gifts or money paid into trust is free of IHT, provided you live for another seven years.

So it pays to plan in advance, McCann said. “Provided you’re in good health when you put it into trust, there are normally no inheritance tax implications.”

But he cautioned: “If you die within seven years, HMRC could seek to include that value in your estate and charge IHT.”

There is another advantage in putting life insurance inside a trust, McCann added. “It can also mean a speedier pay out in the event of a claim, as your family won’t need to wait for probate.”

This can make a huge difference to dependants relying on the money to cover day to day bills, he said.

So check your IHT planning is trustworthy, or seek independent financial advice.

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