With massive changes to the IHT landscape, including the significant implications for farmers, Ingrid McCleave, Partner at Law firm, DMH Stallard, shares her valuable insights with us into some of the ways in which advisers can use protection policies in a highly tax-efficient way to support clients’ financial plans.
The fallout from last autumn’s Budget continues to resonate, not least in relation to the UK’s inheritance tax (IHT) regime. But for those most affected, there is a way to mitigate the impact on their beneficiaries: writing a life insurance policy in trust.
The Budget announced major changes to IHT asset reliefs – Agricultural Property Relief (APR) and Business Property Relief (BPR) – which have been part of the tax landscape for more than 40 years. Designed to protect family farms and other businesses after the owner’s death, changes to these reliefs will take effect in April 2026, primarily affecting farmers, family businesses, and from April 2025 for non-domiciled individuals (non-doms).
The availability of 100% relief under APR and BPR will be subject to a combined £1m cap. Currently, no cap applies to either relief. Rather than the standard IHT rate of 40%, a new reduced rate of 20% will apply above the £1m figure.
These changes have provoked angry protests from farmers. Their argument is straightforward: APR enables the country to keep producing its own food. They may be less high-profile, but small businesses are also feeling the pain. Currently, trading businesses can be passed down without incurring IHT. But from April 2026, those which are valued above £1m will subject to the new 20% rate.
Non-doms are also in the firing line. A new four-year foreign income and gains (FIG) regime was introduced in the Budget, for individuals who become UK tax resident after ten tax years of non-UK residence. For non-doms, the IHT regime will move to a residence-based system from April 2025. Long-term UK residents (resident for at least ten of the last 20 tax years) will be subject to IHT on their personally owned non-UK assets.
Taking out a life policy in trust can help protect beneficiaries from a potential IHT liability, or mitigate its impact. IHT is avoided because HMRC does not consider the payout to form part of the policyholder’s estate. Although expensive for older policy holders, a tax-exempt insurance payout will be much more cost effective than being subject to a large IHT bill.
In essence, a life insurance policy held in trust protects assets held within it. Flexible and relatively straightforward to implement, it ensures that IHT can be paid quickly. An appropriate bespoke clause will allow details to be easily updated. Such policies can provide a payout to cover any IHT that is anticipated, which avoids the beneficiaries having to sell property or other assets to pay the tax bill.
So, how does it work?
To create a “life policy in trust” requires putting it within a legal trust structure. In establishing and managing such trusts, it is best to use professional advisers. It is important to note that the policy cannot be directly owned by the individual; instead, trustees manage the trust on their behalf.
The first option is a bare trust in which beneficiaries have an immediate, absolute right to a policy payout. These are typically used for specific beneficiaries, such as children or spouses. Alternatively, a discretionary trust can be used, which provides greater flexibility. They are often chosen when greater control over the distribution of funds is needed. Trustees can decide how and when proceeds from the policy are distributed to the beneficiaries.
In both types of trust, trustees will need to be appointed and beneficiaries designated by the settlor, the person who creates the trust. Bespoke clauses should then be drafted to meet their circumstances and wishes. Examples of a bespoke clause include giving the settlor the freedom to add or remove beneficiaries. Without such a clause, they will not have the ability to do so.
Payout from a life policy in trust can be distributed to the beneficiaries without it being considered as part of the taxable estate for IHT purposes. They can then decide whether to use the proceeds to pay any IHT that is due.
A life policy in trust can help to prevent some farming families from having to sell their Estate, or businesses having to sell assets to meet IHT requirements. They can also be beneficial for non-doms who may intend to leave the UK, mitigating the risk of dying whilst they are still subject to IHT in the UK.
Life insurance can be broadly divided between term insurance and whole of life plans.
Term life insurance provides coverage for a set number of years (the term), typically between ten and 30 years. Although cheaper, it only pays out if the policyholder dies within the term of the policy and accrues no cash value.
Commonly known as life assurance, whole-life plans provide lifelong coverage. Inevitably, premiums are higher and usually increase over time, as does the tax-free cash value amount. A calculation of the current IHT due is required before insuring this figure with a whole-life policy linked to the retail price index (RPI). Anticipated growth on the estate above RPI will be needed to be accommodated in the amount insured.
Gifts are another consideration. Term life policies can be used for gift-related IHT exposure. No changes were made to the taxation of gifts in the Budget: lifetime transfers in the seven years before death still apply; gifts made more than seven years prior to death are IHT exempt; those made less than seven years before death are captured. No IHT reduction applies if death occurs within three years of a gift being made, while those made more than three years, but less than seven years, may be subject to IHT on a tapered basis (taper relief) if the gifts were above the nil rate band of £325,000. A fixed period policy up to seven years after an asset is gifted can mitigate against the donor dying within the seven-year window, and the gift becoming subject to IHT.
Given the scale of IHT relief changes, the benefits of putting a life policy in trust are self-evident. As more people choose this option as part of their IHT planning, farming and business-owning families will be able to avoid having to sell their assets in order to pay the taxman.
About Ingrid McCleave
Ingrid is both a solicitor and a barrister and is known for her considered approach to inheritance tax planning. She is a Partner at DMH Stallard and has developed a specialism in tax and succession planning with in-depth experience of both corporate and private client tax practices.
About DMH Stallard
DHM Stallard is an award winning South East law firm with offices in London, Brighton, Gatwick, Guildford, Hassocks and Horsham. The firm has grown rapidly since it was established in 1970 and continues to maintain its focus on building long term relationships with clients to help deliver their goals and objectives.
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