Over the years, successive UK chancellors have conducted reviews of various aspects of the inheritance tax (IHT) framework.
These reviews have encompassed alterations concerning non-domiciled individuals and the decision to maintain the nil-rate bands at the same levels until 2028.
This ongoing assessment has given rise to considerable debate, rendering it one of the most contentious taxes. In the fiscal year 2022/23, IHT revenue surged by £1 billion, reaching an unprecedented peak of £7.1 billion. Projections indicate a further increase to approximately £8.3 billion in 2026/27, possibly even earlier. Notably, the number of estates subject to IHT has doubled since 2019, and the average tax bill now exceeds £216,000.
As planners, there’s a huge opportunity for us to be creative when it comes to IHT planning, and there are many tools in the IHT planning box. In this article, I’m going to explore the use of Whole of Life (WOL) policies within IHT planning, and how I approach this with clients.
Background to WOL policies and the different ways to look at them
But first, what is a WOL policy? Put simply, it’s when a client sets up a trust (often discretionary) and purchases a guaranteed investment surrender value that is underwritten by an insurance company. What is not to like? Imagine someone promising a guaranteed return on investment - sound too good to be true?
While there are many IHT planning tools, the use of WOL policies to generate a lump sum to pay the IHT have grown in popularity because clients get to retain access and control of their hard-earned wealth (as opposed to gifting it all), while only having to pay a guaranteed premium, monthly or annually.
Take Mr and Mrs Sims, both aged 60, who have an IHT liability of £600k and want to start the journey of planning for their IHT bill. (Note; the older the client the less attractive this tool becomes, and other planning ideas become more favourable.)
There are a few exemptions from IHT that, if not used on an annual basis, are lost. Apart from small gifts, the main exemptions to consider are Normal Expenditure from Income (NEI) and the Annual Capital Exemption (ACE). The latter is available to everybody and is limited to £3,000 per year, per donor.
The value of the £3,000 if left in their estate is £1,800, assuming 40% IHT would be payable on death on this sum. Mr and Mrs Sims could use their annual exemptions (£3,000 x 2) to fund an annual premium of £6,000 to a WOL policy. The death claim value on the second death, as at the date of writing this, and a clean slate of health, is £488,000 (the highest sum assured provided from Iress Exchange). This amount would be payable under a trust on the second death completely free from IHT. This would help Mr and Mrs Sims’ children partly pay the IHT bill due on their late parents’ estate.
Ways to analyse the WOL policy from an investment perspective
- Given the impact of a 40% IHT on the estate, a £6,000 capital value would effectively reduce to £3,600 meaning the annual net premium would be £3,600. To break even with the IHT impact, the individual would need to live for an astonishing 135 more years, reaching the age of 195.
- If both Mr and Mrs Sims pass away at age 87, they would have paid £168,000 in gross premiums over their lifetimes (£6,000 per year), resulting in a pay out of £488,000. This equates to a compounded annual return of 6.83%.
- Using the net premium of £3,600 annually, they would have contributed £100,800 over their lifetime (£3,600 per annum). However, they would receive a pay out of £488,, yielding a compounded return of 9.63%.
In addition, Mr and Mrs Sims could opt to fund the annual premiums using growth/interest from their cash, ISAs, bonds, or GIAs. This strategy allows utilising investment growth to cover the policy premiums effectively.
Through the illustrative case of Mr and Mrs Sims, the article showcases how these policies can be a valuable tool in IHT planning, offering insights into their potential returns and benefits in mitigating IHT impact.
Please note of course: there are many considerations to consider as is often the case and its not a one size fits all model!
In my next article, I’ll delve into the synergy between WOL policies and a Discounted Gift Trust, illustrating how this combination can lead to an optimised outcome in the realm of IHT planning.
