We’re a married couple with two teenage children. We own our main home outright, which is worth about £525,000 and we also have one rental property, which was inherited by my wife, worth £198,000. I’m a higher rate taxpayer and we’ve recently been reviewing our finances and estate planning. 
 
We both have life insurance policies in place, and I’m trying to understand how they’re treated for inheritance tax purposes (IHT). If one of us passed away, would the life insurance payout be included as part of the estate and potentially push us over the IHT threshold, or does it depend on how the policy is set up (e.g., written in trust)? How do people usually structure this to avoid unexpected tax issues for their family? 

Arthur Weller replies: 

The answer to your question is that it depends on how the life insurance policy was written. See HMRC’s Inheritance Tax Manual at IHTM20211; under normal circumstances, the payout is treated as part of the estate of the deceased. However, if the policy is written in trust for (say) children or a discretionary trust, the payout will not fall into the estate. So, I would advise you strongly to enquire about your policies, and if they are not written in trust, seek advice about changing them.