How life insurance can protect against IHT liability
© Adobe Stock Many farmers are investigating the cost of life insurance in the light of the cut in inheritance tax (IHT) reliefs which is due to take effect from April 2026.
The most cost-effective solution will often be a mix of different types of cover over different term lengths, say advisers, who 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 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 and take £2m of cover up to the age of 70, and £1m whole of life cover.
“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 being handed assets or who may be handed assets in future.
“For the younger generation, level term cover is a good idea, for example, to protect that period when their children are up to 18 or 25 years old.”
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 and 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 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.
“We are doing an awful lot of this sort of cover because this way you can make the gift a closed deal and not have to worry about the potential IHT impact.”
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, but hazardous changes to your lifestyle do not generally cause rates to go up,” 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 (for how long?) until the individual no longer is a user.
Not all hazardous activities will be a problem for obtaining life insurance, says Holly, but some examples that would need further investigation would be skiing off piste without a guide, wreck diving, mountaineering, solo flying and horse racing.
Arranging life cover will usually involve a medical report, which can take several weeks to obtain if not longer, 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 market, avoiding the need for multiple reports.
Types of life insurance
There are three main types of cover:
Whole of life
Just as it sounds, this type of policy pays out on death provided the premiums are paid. 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.
In all cases, policies 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 separate or divorce, the cover no longer matches the liability, points out Holly.
“This can be catered for by having an appropriate separation clause. This can provide either for the cover to be split to cover two single lives or can move all the cover to one life.
“If there is no separation clause then the policy is defunct and you need to buy single life cover.
“Where there is a separation clause, it’s important to check that it will do what is wanted, as some are not well written.”
Warning on reviewable premiums
Whole-of-life policies can be on the basis of either fixed 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.
“The reviews are generally at 10-yearly intervals and there have been a lot of complaints to the Financial Conduct Authority about how much premiums have risen, for example tripling in some cases.”
William advises that taking out several policies of different types to cover different terms and levels of risks can be cheaper than trying to cover all eventualities with one policy.
“For example, you might not be in a position to gift assets now but want the liquidity of having a potential payout from a term cover for the next 10 to 15 years at age 55 and take a separate cover [at the same time] for the 20 years taking you to 75.
Accountant report shows challenge of covering the risk
Accountant Sam Kirkham is 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 met 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 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.”
Her further advice includes:
- It is essential for policies to be written in trust, so that the proceeds remain outside of an individual’s estate for IHT
- Make sure that what is in the will matches with what the life insurance policy says in terms of who the life policy proceeds should go to
- 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.