Life policies after death – avoid this common pitfall

Inheritance Tax (IHT)

If the policy is written in trust, it’s the trustees’ responsibility to deal with any IHT liability that arises from the proceeds paid to the trust fund. The IHT liability, if any, will depend on when the trust was established, if the proceeds exceed the Nil Rate Band which is currently £325,000 and when the beneficiaries of the trust receive funds. 

When a policy is not written in trust, the value of the policy may need to be added to the deceased’s estate. This means PRs may need to include the value of life policy at the date of death on the deceased’s IHT Account when reporting to HMRC.

Income Tax

If a chargeable events certificate is issued by the life assurance company, it has nothing to do with Capital Gains Tax (CGT), because chargeable event gains on life assurance policies fall outside the CGT regime. The chargeable event gain is subject to Income Tax and needs to be reported to HMRC by the PRs of the policy holder, on the deceased’s tax return to the date of death (even if the policy was written in trust). However, PRs may not receive correspondence from the life assurance company, especially if the policy was written in trust. So, if a chargeable event gain certificate was issued, the PRs might not know about it, meaning that they could miss HMRC’s reporting deadline for the chargeable event gain. 

Even if the PRs are aware of the chargeable event gain, they may be unaware of the availability of top slicing relief. In simple terms, the effect of top-slicing relief is to treat the gain as if it arose evenly while the life assurance policy was held, meaning the tax position is calculated without the ‘bunching’ effect. This may substantially reduce or even eliminate an Income Tax charge altogether. This is a very simplified statement of the position, as the taxpayer’s other income and any previous partial encashments from the policy also affect the Income Tax charge of the chargeable event gain, so the calculations can be complex. Changes in recent years have also affected the way top slicing relief is calculated, which has meant that even HMRC’s system sometimes struggles to deal with the calculation correctly. 

What should you do?

If you’re a PR and you find paperwork relating to a life assurance policy after someone dies, you should seek professional advice to ensure the tax position is dealt with correctly and you don’t get caught out by these common tax pitfalls.

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