Inheritance Tax, and How Insurance Can Help Mitigate Its Impact

Inheritance tax (IHT) is levied on an estate — securities, real estate, etc. — passed on by the deceased to the beneficiaries. The tax amount varies based on the value of the estate and how it is inherited. Though inheritance tax is a common practice across the world, its stipulations vary significantly between countries. For example, there is no standard IHT regime in the UAE. However, the inheritance tax among G7 countries is 17% of the total taxable estate, on average — which can go up to 55% in Japan. 

Inheritance tax becomes applicable when the estate’s value exceeds the nil-rate band threshold, which can be relatively low, resulting in substantial taxation. Since IHT is typically a non-recourse liability, beneficiaries are often compelled to pay high taxes to inherit the estate. Failure to pay can lead to legal complications, accruing interest, and, in extreme cases, the liquidation of assets.

How Life Insurance Comes Through

In regions where inheritance taxes are especially high, permanent life insurance products are often used to mitigate the financial burden. Permanent life insurance — including whole life or universal life policies — purchased in the benefactor’s name can provide beneficiaries with a financial cushion when inheriting the estate. The substantial payout from these policies can cover IHT, legal fees, and other expenses. Additionally, since the cash-value component of permanent life insurance grows on a tax-deferred basis, the payout can become a significant part of the estate itself.

Permanent life insurance, particularly high-value products, can be structured to cover inheritance tax, legal fees, and the needs of multiple beneficiaries. This flexibility is especially useful for family offices with numerous heirs and properties that cannot be divided evenly. In cases where beneficiaries are not entitled to an equal share of the estate — such as when one has special needs or has contributed more to the benefactor’s well-being — life insurance payouts can be used to balance inheritances or make special provisions for specific heirs.

Typically, life insurance payouts are not taxed up to a certain limit. However, if they are structured as part of the estate, they may be subject to taxation in some cases. To avoid this, it’s often recommended to place the life insurance policy in a trust. This strategy keeps the policy’s proceeds outside the estate’s scope and, therefore, outside of inheritance tax obligations. Trusts function as independent entities while providing beneficiaries with strategic access to capital. In the Middle East, private trusts can be established in financial free zones like the Dubai International Financial Centre (DIFC) and Abu Dhabi Global Market (ADGM).

Leveraging Irrevocable Life Insurance Trusts (ILITs)

High-net-worth individuals (HNWIs) often use irrevocable life insurance trusts (ILITs) to further minimize tax exposure. In an ILIT, a third-party lender finances the life insurance premiums as a loan to the trust, with collateral used to secure the arrangement. This structure is particularly beneficial for benefactors with estates largely composed of illiquid assets, as it allows for external premium financing. More importantly, ILITs demonstrate the flexibility of permanent life insurance, which can be customized to suit various legacy planning strategies and wealth management needs.

Life insurance has become an essential tool in legacy planning, gaining widespread recognition from financial advisors and wealth managers for its tax efficiency and risk mitigation. Additionally, the cash-value component of permanent life insurance policies allows policyholders to use them as collateral for loans or to surrender the policy for an immediate liquidity boost. In essence, life insurance provides protection during both life and death — a benefit that few other investment instruments offer.