05 Dec 2017
Whole of Life Assurance – value for money?
The only certainties in life are death and taxes, so a product that can be used to pay tax on death should be considered seriously to reduce IHT.
While there are many ways to mitigate against inheritance tax it is not always possible to do so easily, perhaps because of the illiquid nature of assets such as property, or because of a wish to maintain capital in retirement for future unknown eventualities.
Whole of Life Assurance is an option available for those in good health. Unlike Term Assurance that will expire after a set period, Whole of Life (WOL) policies provide cover for the remainder of an individual or couple’s life. WOL policies can be set up with reviewable or guaranteed premiums.
Reviewable premiums tend to increase exponentially with age so although they are more expensive initially, guaranteed premiums are generally the preferred option and this article considers this option only. Guaranteed premium policies do not have any investment element (surrender value) and will only pay a lump sum on death.
A WOL policy does not reduce the value of an estate for inheritance tax, but rather provides a cash sum to pay the tax due.
Typically a WOL policy will be written in trust meaning that the sum assured when paid out is not part of the deceased’s estate and not subject to inheritance tax. The premiums paid will also not be subject to inheritance tax provided they are shown to be funded from surplus income or part of the £3,000 annual gift allowance.
If held under trust the policy proceeds are not held up subject to probate being granted so can give dependants access to funds quickly following death. It should be pointed out that other than the premiums being paid, a WOL policy does not reduce the value of an estate for inheritance tax but rather provides a cash sum to pay the tax due.
The most common question clients ask when considering WOL as an option is, ‘Is it value for money?’ To help answer this I have set out below how long it would take to build up a fund equivalent to the sum assured of £1m assuming the equivalent premium was instead invested.
Where cover is provided for married couples or civil partners it will usually be provided on a ‘Joint Life, Second Death’ basis which means that the sum assured is paid when the second party dies, as this will typically be the point at which inheritance tax is due.
I have used the standard FCA assumptions as regards investment growth of 2%, 5% and 8% and assumed charges of 1% p.a. I have not taken into account any tax deductions that may apply nor have I allowed for inflation.
|Age||Premium p.a.||Years to build equivalent fund|
Source: Iress 19/10/17. Assumptions: Joint Life Second Death, no age difference between partners. Cover of £1m accepted at ordinary rates with guaranteed premiums and no fees.
We can see from this table that, for example, assuming a gross investment return of 5% p.a. at least one of a 55-year-old couple would have to live to age 97 before they had accumulated the equivalent of the lump sum that would be paid out on the second death. The current average life expectancy for a man and woman aged 55 is 86 and 88 respectively (source: Office for National Statistics).
If an investment offering this return was available now it could prove very popular, but the caveat is that those doing the investing will never personally reap the reward and 30+ years is a long time to maintain premiums.
They will, however, have the comfort of knowing that they have made available a tax-free lump sum to provide for the tax so their dependants will be able to benefit from their inheritance without losing a large proportion of it to the tax man.
Provided premiums are maintained the sum assured is guaranteed to be paid on death. The importance of being able to maintain the premium for life cannot be understated. Failure to do so would cause the policy to lapse without value. It should also be remembered that average life expectancy is just that, an average. Many people will live longer than average and being part of a couple increases the chances of one party doing so.
In summary, therefore, where affordable over the long term, and where perhaps other estate planning solutions are not possible or suitable, a Whole of Life policy can be considered an effective vehicle to make provision for the next generation tax efficiently and can provide funds quickly following death.
Please contact a member of the financial planning team if you would like to discuss Estate Planning and the options available.
This article is not intended to constitute personal advice and no action should be taken, or not taken, on account of the information provided.