When considering the implications of passing on your estate after your death, there’s a good chance that you, like many others, will want to minimise the tax your loved ones will pay on their inheritance.
In the UK, everyone has a personal inheritance tax allowance. This amount - which currently stands at £325,000 - is completely exempt from any inheritance tax liability and is known as the nil rate band. Any assets you pass on above this amount are taxed at the inheritance tax rate of 40%.
You may, however, find yourself in the position to pass on a portion of your estate whilst you are still around to see your loved ones enjoy it. This type of gift is known as gift ‘inter vivos’. This latin term loosely translates to a gift ‘between the living’.
If you choose to pass on portions of your estate in this way, it is important to remember that these gifts are not exempt from inheritance tax.
This is where gift inter vivos insurance comes in.
What is Gift Inter Vivos insurance?
Under UK law, if you happen to pass away within 7 years of making a gift in excess of your nil-rate band, the beneficiary of your gift is liable to pay the inheritance tax due on it. However, so long as you stay alive for 7 years (in most circumstances) after giving it, your gift is exempt from inheritance tax.
A gift inter vivos insurance policy is a form of Term (life) insurance that will cover the potential Inheritance Tax (IHT) liability created when you gave that sum of money or other assets away while you were alive, should you happen to pass away in that 7 year period.
How does gift inter vivos insurance work?
Once you have given your gift, the potential inheritance tax liability reduces over the subsequent 7 years. Whilst you have a full 40% liability if you die shortly after you make a gift, any gifts which you make 3 to 7 years before death are taxed on a sliding scale. This reduction in liability is commonly known as taper relief.
The amount which your gift inter vivos policy pays out is in line with the amount liable to be paid for inheritance tax. The value of the payout drops and matches the inheritance tax taper relief over the 7 years.
It’s important to note that even though the cover reduces over the 7 years, the premium typically remains fixed for the whole term life of the policy.
However, before setting up a gift inter vivos policy it’s important to establish whether taper relief will actually apply, as any gifts you give will first of all be allocated against your nil rate band when you make them. It is worth speaking to an insurance broker to see how this may affect whether you feel a gift inter vivos policy is right for you.
Summary
It’s vital to have adequate insurance to protect your loved ones should the worst happen.
If you fail to implement some form of protection, your loved one might be liable to pay a large sum of inheritance tax if the gift amount is particularly substantial, losing out on a large part of your estate as a result. Taking out protection is made all the more important if you are in poor health, if you have a hazardous job, or are at an advanced age.
Without a gift inter vivos policy, you run the risk that the recipient of your gift may have to pay inheritance tax even though they have already spent the money, or if the gift isn’t cash but something tangible instead, such as expensive jewellery.
For example, if you gave the gift to a loved one so they could buy a house and the sale goes through, then it’s unlikely that they will have the spare capital to pay the inheritance tax bill due a number of years after the gift was made. They would then most likely not only have to go through the rigmarole of selling the property, but they would also lose part of the value too.
These issues can all be easily avoided by thinking ahead and implementing a gift inter vivos policy.
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