As we approach the Budget on 26 November 2025, there are many rumours about which taxes chancellor Rachel Reeves could change.
While it’s not yet clear whether taxes will rise, many commentators expect some changes to Inheritance Tax (IHT) and the gifting rules. This could make it more difficult to reduce the IHT liability of your estate.
Any further changes would be an additional blow as the government recently confirmed that pensions would no longer be exempt from IHT from April 2027 onward.
All existing and potential overhauls of the IHT rules come at a time when the number of estates liable for the tax is on the rise, while the amount that families can expect to pay is also increasing.
Fortunately, a life insurance policy could help your family cover the cost of a large IHT bill, meaning they retain more of their inheritance.
Read on to learn how this works.
Your beneficiaries will pay Inheritance Tax on any wealth that exceeds your nil-rate bands
When you pass away, the executor of your will must calculate how much IHT is due on the estate. To do this, they add up the total value of your taxable assets. Then, they apply the “nil-rate band” – an IHT-free allowance you can benefit from.
In 2025/26, the nil-rate band is £325,000. You may also benefit from the “residence nil-rate band” of up to £175,000 if you pass your main home – the one you live in – to a direct descendant such as a child or grandchild.
This means you have an IHT-free allowance of up to £500,000. Any wealth that exceeds the nil-rate bands is subject to 40% IHT.
However, if you’re married or in a civil partnership, you can pass your entire estate to your partner without IHT. When your partner passes away, they benefit from your unused nil-rate bands, meaning that you could pass on up to £1 million between you as a couple.
Unfortunately, the nil-rate band has been frozen since 2009, and the residence nil-rate band hasn’t increased since 2017. The chancellor confirmed that this freeze would remain until April 2030.
Meanwhile, house prices have increased rapidly, wages have risen, and you may have generated growth on your savings and investments. As such, the value of your estate is likely increasing while the nil-rate bands are static.
This is why IHT receipts are rising and more families are being pulled into paying the tax.
According to the UK government, IHT receipts for April 2025 to August 2025 were £3.7 billion – an increase of £0.2 billion on the same period the previous year.
We can support you in finding ways to reduce the tax liability of your estate, but your family may still have to pay some IHT when you pass away.
A life insurance policy could help them cover this cost.
As with most insurance-based contracts, they’re underwritten, and various health factors are taken into consideration during this process. However — assuming the costs are affordable — it can still be worthwhile to take out a policy, as it provides financial protection for dependents and peace of mind regardless of health factors. Given that premiums typically rise with age or deteriorating health, it’s often advantageous to secure cover sooner rather than later. It’s also very important that you structure the policy correctly to achieve the desired benefit.
A life insurance payout may form part of your estate for Inheritance Tax purposes
If you take out life insurance, your family can use the funds to pay an IHT bill. This could mean that they don’t lose as much of your wealth to tax when you pass away.
However, it’s important to understand the tax treatment of a life insurance payout.
Normally, when you pass away, the funds from your life insurance will be paid to your estate. The executor of your will must then include this wealth when calculating how much IHT is due.
Consequently, if the rest of your estate exceeds the available nil-rate bands, your beneficiaries may pay 40% IHT on the proceeds from your life insurance policy.
Placing life insurance in a trust could shield the funds from Inheritance Tax
A trust is a legal arrangement that allows you to pass ownership of an asset to a trustee. This person then manages the asset on behalf of a third party (your beneficiary) according to the rules of the trust.
If you place a life insurance policy in a trust, you no longer own it. As such, the funds are not included in any IHT calculations, and your beneficiaries retain the full amount.
This means they can use the funds to pay any IHT due on your estate.
Additionally, they could receive the funds far sooner if you place the policy in a trust.
Ordinarily, if the policy isn’t in a trust, the funds are paid to the estate. Your beneficiaries will not be able to access this wealth until the probate process is complete. Any outstanding IHT must be paid as part of this process, meaning your family will have to cover the cost upfront and reclaim it when they inherit from the estate.
In comparison, if the policy is in a trust, it does not form part of the estate, so there is no need to wait until probate is complete. Instead, the funds are paid directly to your beneficiaries.
This means they can clear any IHT bills and potentially pay for other expenses, such as a funeral. They may also use the funds to cover living expenses, giving them more financial security after you pass away.
Get in touch
We can support you and your family in finding ways to reduce and manage a large IHT bill.
Please get in touch to find out how our team of VouchedFor Top Rated planners could help today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, trusts or will writing.
Note that life insurance typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.
Cover is subject to terms and conditions and may have exclusions. Definitions of illnesses vary from product provider and will be explained within the policy documentation.