Using life insurance in trust to pay an inheritance tax bill
Inheritance tax has a timing problem that catches families out. The bill is due within six months of death, and HMRC generally wants paying before probate is granted. But the money that would pay it — the house, the investments, increasingly the pension — is locked up until probate comes through. Executors end up borrowing, or selling in a hurry, or both.
A life policy written in trust is the standard answer. It does not make the tax bill smaller. It makes sure there is cash to pay it, in the right hands, at the right time.
What changes in April 2027
Until now, a defined contribution pension pot has been the most tax-efficient thing you could leave behind. It sat outside your estate and passed to your nominated beneficiaries without inheritance tax.
That ends. Finance Act 2026 received Royal Assent on 18 March 2026, and for deaths on or after 6 April 2027 most unused pension funds and death benefits are included in the value of your estate for inheritance tax. If your estate then exceeds the available nil-rate bands, that pension money is taxed at 40% like everything else.
Four things stay outside the charge, and they matter:
- Dependants' scheme pensions — an ongoing income paid to a spouse, civil partner, child, or someone financially dependent on you.
- Trivial commutation lump sums paid in place of a dependant's pension.
- Joint life, nominees' and dependants' annuities bought with a lifetime annuity.
- Death-in-service benefits, where you were in employment or other work immediately before death.
That last exclusion is worth knowing if your main cover is through your employer — see is death-in-service cover enough. Those benefits still have to be reported to HMRC, but they are not caught by the new charge.
The thresholds the bill is measured against
The nil-rate band is £325,000. The residence nil-rate band adds up to £175,000 where you leave a home to direct descendants. Both are frozen until April 2031, which means every year of house-price and pension growth pulls more estates over the line without any rate ever changing.
A couple who can use both bands in full can pass on up to £1 million between them. Above that, 40%. And the residence nil-rate band is withdrawn by £1 for every £2 by which the net estate exceeds £2 million — so a large pension newly counted in the estate can quietly destroy the residence band as well as being taxed itself. That is the part people miss: the pension does not just add to the bill, it can reduce the allowances too.
Why the policy has to be in trust
This is the whole point, and it is where the expensive mistake gets made.
A life policy that is not in trust pays into your estate. That increases the estate, and if you are already over the threshold, HMRC takes 40% of the payout. A £200,000 policy bought to cover a tax bill hands £80,000 of itself straight to the Revenue and leaves £120,000 to do a £200,000 job.
Written in trust, the proceeds are not yours to leave. They belong to the trust, they are paid to the trustees, and they sit outside the estate. Two consequences follow. The payout is not taxed as part of the estate, and it does not wait for probate — trustees can usually be paid within weeks, which is exactly the window in which executors need cash. See is life insurance taxable in the UK for how this sits alongside the other tax questions.
Most insurers provide their own trust deed at no cost, and putting a policy into trust at the point of application is a form-filling exercise, not a legal project. Doing it later is also possible, but the transfer itself is a gift, so it is cheaper to get it right at outset.
Term cover is usually the wrong tool here
An inheritance tax liability does not expire. Term cover does. If you buy a 20-year term policy at 60 to cover an IHT bill and live to 85, you have paid premiums for two decades and there is nothing to show for it — see what happens when life insurance ends.
For a permanent liability the matching product is whole-of-life cover, ideally on guaranteed premiums rather than reviewable ones, so the cost cannot be re-rated upwards when you are 80 and cannot go anywhere else. It is markedly more expensive than term for the same sum assured, and that is not a mispricing — it is the price of a payout that is certain rather than conditional. Term versus whole-of-life sets out the trade-off in general terms.
For a married couple or civil partners there is a further refinement. Transfers between spouses are exempt, so no inheritance tax is normally due on the first death — the bill lands on the second. A joint life second death policy is priced for that, and costs less than two single policies because it only has to pay once, later.
Paying the premiums without creating a second problem
Premiums paid on a policy held in trust are gifts. Left unmanaged, they are potentially exempt transfers with their own seven-year clock, which is an odd result for a scheme designed to solve an inheritance tax problem.
In practice two exemptions usually absorb them. The annual exemption covers £3,000 of gifts a year. More usefully, the exemption for normal expenditure out of income covers regular gifts made from surplus income that do not reduce your standard of living — which is exactly what a monthly whole-of-life premium looks like, provided you keep a record showing the income was genuinely surplus. Keep that record from the start; it is the executors who will have to prove it.
What this does not do
Be clear about the limits. A policy in trust does not reduce the tax, avoid it, or change the value of the estate. Anyone selling it as inheritance tax "mitigation" is overstating it. The bill is the same size — you have simply pre-funded it, at a cost, so your family does not have to raise the money by selling the house.
Whether that is worth doing depends on whether the estate has liquidity. An estate that is mostly cash and listed investments can pay the bill without much difficulty. An estate that is a house, a business, and a pension usually cannot, and that is where the policy earns its keep. How much life insurance you need covers sizing cover for family income; sizing it for a tax bill is a different calculation, done against a projected estate value rather than a replacement income.
What to do before April 2027
Get the estate valued as it will look under the new rules, pension included, and see whether it crosses the threshold at all — many will not. If it does, work out what the bill would be and whether the estate could pay it without a forced sale. Then, and only then, price whole-of-life cover for the shortfall.
Two housekeeping points while you are there. Check whether existing policies are actually in trust, because a surprising number are not and their owners believe otherwise. And check your expression of wish with your pension scheme, because from 2027 the personal representatives, not the scheme, carry the reporting and payment obligation, and they can withhold up to half of a benefit while the tax position is settled.
This is an area where the interaction of trust law, pension rules and inheritance tax genuinely warrants professional advice. The purpose of this guide is to let you arrive at that conversation knowing which questions to ask.