LIFE POLICY ARRANGEMENTS FOR INHERITANCE TAX PLANNING
21 April 2021
A Whole Life Assurance Policy pays the agreed death benefit whenever the life assured dies. An own life policy is a policy on the life of the policyholder who is also the life assured. The death benefit belongs to the estate of the policyholder. It increases the value of the estate. Since it forms part of the total assets that makes the value of the estate, it is subject to inheritance or estate tax.
For the purpose of inheritance or estate tax, the policyholder should not directly own the death benefit to avoid the tax. This requires proper planning and arrangement. Two options are open to the owner of the estate while alive. There is a third option in countries where a surviving spouse can inherit the estate of a deceased spouse free of inheritance tax.
One of the two options is to make the life policy a Trust Policy. The Rich creates a trust and appoints Trustees with the responsibility of paying the inheritance or estate tax. The Trustees buy the policy on the life of the Rich, the creator of the estate. They derive their insurable interest in the life of the Rich to the extent of the inheritance tax on his/her death. The Rich is the life assured. The Trustees are the policyholder. On death, the life insurer pays the death benefit to them. On receipt of the proceeds, they have the fund to pay the tax due on the estate.
NAMED BENEFICIARIES POLICY
A Named Beneficiary policy is a life policy a person takes on his/her own life. He/she is the life assured and also the policyholder. The policyholder gives the names of the beneficiary or beneficiaries with their details to the life insurer. The insurer will pay the death benefit to them whenever the life assured dies.
The death benefit is tax free as it does not form part of the deceased’s estate. The beneficiaries have a source of fund for paying the inheritance tax. It relieves them and the Executors or Administrators of the financial stress of sourcing the fund elsewhere.
You remember that the policy is a Whole Life Assurance bought with the intention of using the death benefit to pay the tax due on the policyholder’s estate. To ensure that whoever receives the policy proceeds are the ones who will benefit from paying the inheritance or estate tax, the estate owner has to name them as beneficiaries of the estate in his/her will. This is to avoid the named beneficiaries using the proceeds for purposes other than paying the inheritance or estate tax.
Apart from the proceeds being tax free in this arrangement, a major advantage of a named beneficiary policy is the control the policyholder has on the policy while alive. He/she can change the named beneficiaries while alive. The policy can also serve as a source of liquidity since the policyholder can take a policy loan on the policy’s cash value.