The Role of Life Insurance in Managing Inheritance Tax

Life insurance is often discussed in the context of mortgages, income replacement or family protection. Increasingly, it is also being drawn into inheritance tax planning conversations. When structured correctly, it can provide critical liquidity at death and prevent families from being forced into rushed or suboptimal decisions. When used in isolation, however, it risks becoming an expensive sticking plaster rather than a coherent solution ^[1].

The challenge is not understanding what life insurance does. It is understanding what role it should play. As Alex Pugh, Chartered Financial Planner and Partner at Saltus, explains, “protection can be a complete solution, but if you try to use it that way, it becomes very expensive.” The real value lies in how it integrates with the rest of the estate plan, not in the policy itself.

Why Life Insurance Has Become More Relevant

Inheritance tax has always been an emotive subject, but its reach has widened significantly. Nil-rate bands have remained frozen since 2009, while asset values, particularly property, have continued to rise. At the same time, legislative changes mean more wealth is being drawn into the inheritance tax net.

The result is a growing number of estates facing material inheritance tax liabilities, often without sufficient liquid assets to meet them ^[2]. “The overall impact is more people are paying inheritance tax and the people that were already paying inheritance tax are effectively paying higher amounts,” Alex notes. In this environment, life insurance has become a practical tool for managing the consequences of tax, even if it does not reduce the tax itself.

Starting With the Liability, Not the Policy

One of the recurring mistakes in inheritance tax planning is jumping straight to solutions. Alex stresses that the process should begin with clarity. The first step is understanding the size of the estate, the nature of the assets, and the resulting inheritance tax exposure.

Only once that figure is established does the real planning begin. “We always ask how comfortable someone is with the inheritance tax liability they’re facing,” she explains. For some families, paying tax is acceptable. For others, reducing it as far as possible is the priority. Most sit somewhere in between.

This distinction matters, because life insurance does not mitigate inheritance tax in the technical sense. It funds it. Whether that is appropriate depends on affordability, objectives and the alternatives available.

Whole of Life vs Term Insurance

Where life insurance is used for inheritance tax planning, it typically falls into one of two categories: whole-of-life assurance or term assurance.

Whole-of-life policies are designed to pay out whenever death occurs, provided premiums are maintained ^[3]. This certainty makes them attractive for inheritance tax planning, but that guarantee comes at a cost. Term assurance, by contrast, only pays out if death occurs within a specified period. Because it is not guaranteed, it is significantly cheaper ^[4].

Alex illustrates this with a practical example. A married couple aged 70 with a £2 million estate could face an inheritance tax bill of £400,000 on second death. A whole-of-life policy to cover that liability might cost around £700 per month on standard terms. A term policy over 18 years covering the same amount could reduce the premium to around £250 per month.

The trade-off is clear. Certainty costs more. Flexibility costs less, but carries the risk that the policy expires before it is needed.

Insurance as Part of a Blended Strategy

Life insurance works best when it supports other planning strategies rather than replacing them. Gifting, spending, investment planning and trust structures all interact with inheritance tax exposure over time ^[5].

If a family plans to reduce their estate through lifetime gifts, the inheritance tax liability should fall gradually. In that context, a term policy can act as a temporary backstop, covering the risk that death occurs before the strategy has had time to work. As Alex puts it, “it’s usually a blended approach, not a single solution.”

This also addresses one of the most common objections to insurance: the perception of premiums as a sunk cost. By modelling breakeven points and showing how insurance protects against specific risks rather than abstract outcomes, planners can help families understand its role more clearly.

Liquidity Is Often the Real Problem

For many estates, inheritance tax is not just a tax issue but a liquidity issue. Property wealth, in particular, can leave families asset-rich but cash-poor.

Inheritance tax is generally payable within six months of death. Where most of the estate value is tied up in the family home, executors may be forced to sell quickly to raise funds. Life insurance can prevent this outcome by providing immediate liquidity.

The effectiveness of this strategy depends on the policy being written into trust. When held outside the estate, insurance proceeds can be paid quickly without waiting for probate, allowing tax to be settled while preserving the underlying assets. “That speed can make a critical difference,” Alex explains.

Why Insurance Should Not Be Sold in Isolation

Life insurance is often offered opportunistically, bundled with mortgages or introduced by advisers who are not overseeing the full financial picture. This is where problems arise.

Inheritance tax planning is interconnected. Gifting affects affordability. Spending affects sustainability. Investments affect future estate values. Insurance affects cash flow. “Everything has knock-on effects,” Alex says, which is why protection needs to be considered within a wider financial plan, not bolted on as an afterthought.

Used correctly, life insurance provides certainty where uncertainty would otherwise force compromise. Used poorly, it adds cost without solving the underlying issue.

A Tool for Precision, Not Panic

Life insurance can play a valuable role in inheritance tax planning, particularly where liquidity is a concern or where strategies need time to work. It does not reduce tax, but it can protect families from the consequences of poor timing, illiquidity and rushed decisions.

Its effectiveness depends entirely on context: the size of the estate, the nature of the assets, the affordability of premiums and the wider planning strategy. As with all estate planning tools, the question is not whether it works in theory, but whether it works in this family, at this point in time.