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You might have worked, saved, and invested throughout your lifetime to build a meaningful legacy for your loved ones.
However, without careful planning, the wealth you pass on could be eroded by Inheritance Tax (IHT).
There is one common IHT mistake that could result in your family paying unnecessary tax on their inheritance. According to figures published by Insurance Business, UK adults lost an estimated £346 million in the 2022/23 tax year by not placing life insurance in a trust.
Read on to learn more about how IHT works and how putting life insurance in a trust could potentially help you pass on more of your wealth to loved ones.
If your estate exceeds certain thresholds, your beneficiaries may face an Inheritance Tax bill
In 2025/26, you can pass on up to £325,000 without your beneficiaries having to pay IHT. This IHT-free allowance is known as the “nil-rate band”.
You may also benefit from the “residence nil-rate band” of up to £175,000 if you pass on your main home to a direct descendant (your child or grandchild). As such, you could potentially pass on assets worth up to £500,000 without triggering an IHT bill.
Any amount of your estate that exceeds the nil-rate bands is usually subject to 40% IHT (2025/26).
However, if you leave your entire estate to a spouse or civil partner, they won’t pay IHT. Moreover, your unused nil-rate bands can be transferred to your partner’s estate upon your death. As a result, you could pass on up to £1 million IHT-free as a couple.
Despite these allowances, IHT receipts are rising, and more families are paying tax on their inherited wealth. The latest UK government data shows that IHT receipts for April 2025 to August 2025 were £3.7 billion; this is a £0.2 billion increase on the same period in 2024.
There are several reasons for this increase:
- Frozen nil-rate bands – The standard nil-rate band has been frozen since 2009, and the residence nil-rate band hasn’t changed since 2017.
- Rising prices – Property prices and wages have increased over the same period.
In other words, IHT thresholds have not kept pace with inflation. As a result, if your estate has increased in value over time, your beneficiaries could now face a higher IHT bill than would previously have been the case, or your liability might rise.
What’s more, from April 2027, most unused pension pots and pension death benefits will no longer be exempt from IHT. This is a significant change as pensions have historically been a useful way to pass on wealth tax-efficiently.
Life insurance could help your family pay an IHT bill, but a payout might trigger an IHT charge
While life insurance won’t reduce your estate’s IHT liability, it could provide your family with valuable funds to pay the bill.
However, life insurance providers usually send payouts to the estate of the person who has passed away. As a result, this wealth is included in IHT calculations.
So, if your estate exceeds the available nil-rate bands, your beneficiaries might have to pay IHT on your life insurance funds. This could mean that the payout doesn’t cover the entire IHT bill due on your estate, and your beneficiaries will need to use other funds to pay these charges.
Putting life insurance in a trust could protect funds from IHT
A trust is a legal arrangement that allows you to transfer assets to a person of your choosing (“the trustee”) to manage on behalf of a third party (“the beneficiary”).
If you place your life insurance in a trust, it is legally owned by the trustees and won’t be included in your estate for IHT purposes. As such, any payout will be made directly to your beneficiaries, who will receive the full amount (without any deductions for IHT).
Moreover, your beneficiaries are likely to receive your life insurance funds much more quickly than if you had not wrapped them in a trust.
When life insurance is not held in a trust, the payout is usually made to your estate, which means that your family will have to wait until probate is granted before they receive the funds.
Unfortunately, the probate process is often lengthy. IFA Magazine recently revealed that the number of probate cases taking more than a year to be granted increased by 134% between 2020 and 2023. These delays could be stressful and financially challenging for your loved ones.
So, placing life insurance in a trust could not only protect your loved ones from paying unnecessary IHT, but it could also shield them from additional emotional pressure at a difficult time.
However, there are several types of trust to choose from, each with its own advantages and potential drawbacks. So, it’s crucial that you seek financial advice before putting your life insurance in a trust to ensure your arrangements suit your needs and preferences.
Get in touch
If you’d like assistance planning how to pass your wealth on to your family as tax-efficiently as possible, we can help.
To learn more, please email hello@sovereign-ifa.co.uk or call us on 01454 416653.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning or tax planning.
Approved by Best Practice IFA Group Ltd on 14/11/25