Creating liquidity for inheritance tax: Whole of Life vs Relevant Life insurance

Introduction

When inheritance tax liability exceeds available cash, families face a fundamental problem: how to pay the tax bill without being forced into hurried asset sales. Life insurance written in trust is the most common solution, providing guaranteed liquidity at death that bypasses probate and pays directly to beneficiaries.

Two main policy types serve this purpose: Whole of Life insurance and Relevant Life insurance. Both create immediate liquidity for IHT, but they differ significantly in tax treatment, ownership structure, and suitability for different circumstances.

This page provides a practical comparison to help you understand which approach, or combination of approaches, may be appropriate for your situation.

Quick Comparison

Whole of Life Insurance Explained

Whole of Life insurance provides guaranteed cover for your entire lifetime, paying a fixed sum assured whenever you die. When written in trust, the proceeds fall outside your estate for inheritance tax purposes and are paid directly to the trustees, bypassing probate.

Key Features

• Lifetime cover: Unlike term insurance, Whole of Life continues until death regardless of when that occurs
• Guaranteed payout: The sum assured is paid on death, providing certainty for estate planning
• Written in trust: Properly structured policies are outside the estate for IHT and avoid probate delays
• Premium flexibility: Options include level premiums (fixed), reviewable premiums, or maximum cover structures
• Joint life options: Policies can cover couples on a "second death" basis, paying when the surviving spouse dies

Who Should Consider Whole of Life?

• Individuals and couples with a known, long-term IHT exposure
• Retirees or those approaching retirement who need cover to continue
• Anyone without access to Relevant Life (not employed by a company)
• Those wanting certainty of lifetime cover regardless of employment status

Cost Considerations

Whole of Life premiums are paid from post-tax personal income. Costs vary significantly based on:

• Age: Younger applicants pay less; costs increase significantly with age
• Health: Medical underwriting affects premiums; some conditions may be excluded or rated
• Sum assured: Higher cover amounts mean higher premiums
• Premium structure: Level premiums cost more initially but provide certainty; reviewable premiums start lower but may increase
• Smoker status: Smokers pay significantly higher premiums

Relevant Life Insurance Explained

Relevant Life insurance is a company-owned policy that provides death-in-service benefits for employees, including directors of owner-managed businesses. The company pays the premiums as a tax-deductible business expense, and the proceeds are paid tax-free to the employee's beneficiaries.

Key Features

• Corporation tax relief: Premiums are typically allowable as a trading expense, reducing taxable profits
• No employer National Insurance: Unlike salary or dividends, Relevant Life premiums are exempt from employer NI
• No Benefit in Kind: The employee is not taxed on the premiums (not a P11D benefit)
• Written in trust: Proceeds are paid outside the estate, avoiding IHT and probate
• Linked to employment: Cover typically ends when the employee leaves or the company ceases trading

Tax Efficiency Example

Who Should Consider Relevant Life?

• Directors and shareholders of profitable trading companies
• Key employees who the company wishes to provide death benefits for
• Business owners wanting tax-efficient cover during working years
• Those already extracting maximum tax-efficient salary/dividends

Important Limitations

• Employment requirement: Cover typically ends when you cease to be employed by the company
• Company solvency: If the company ceases trading, premiums stop and cover ends
• Retirement gap: Most people's IHT exposure continues into retirement, but Relevant Life often does not
• Maximum cover: Some insurers limit cover to a multiple of salary; very high sums may require justification

Using Both Together

Many business owners use a combination of both policy types to optimise their IHT planning:

Conversion Options

Some Relevant Life policies offer a "conversion option" allowing you to convert to personal Whole of Life cover when employment ends, without fresh medical underwriting. This can be valuable if your health has deteriorated. However:

• Premiums will be based on your age at conversion (higher than if you had started Whole of Life earlier)
• You will be paying personally rather than via the company
• Not all policies offer this option; check terms carefully

Practical Scenarios

Trust Structures

Both policy types should be written in trust to ensure proceeds fall outside the estate for IHT and are paid quickly to beneficiaries without waiting for probate.

Whole of Life Trusts

• Discretionary trust: Trustees decide who receives proceeds from a class of beneficiaries; flexible but requires clear letter of wishes
• Bare trust: Named beneficiaries receive proceeds directly; simple but inflexible
• Split trust: Separates policy and benefits; can be useful for specific planning needs

Relevant Life Trusts

Relevant Life policies are automatically written under a specific trust structure (a "Relevant Life trust"). The company is the policy owner but not a beneficiary; proceeds are paid to the employee's nominated beneficiaries or their estate.

Making a Decision

The choice between Whole of Life and Relevant Life depends on your specific circumstances. Key questions to consider:

1. Are you employed by a profitable trading company? If not, Relevant Life is not available.
2. How long do you expect to remain employed? If retirement is approaching, Relevant Life alone may leave a gap.
3. What is your company's tax position? Relevant Life is most valuable when the company is paying corporation tax.
4. Do you need certainty of lifetime cover? Whole of Life guarantees cover regardless of employment changes.
5. What is your health status? Both policy types require medical underwriting; poor health affects both equally.