Standard vs. Whole of Life Insurance: Key differences & inheritance planning

What’s the difference between a Standard Life Insurance policy and a Whole of Life Insurance policy

Life insurance is a key part of financial planning, offering peace of mind to families by providing financial security when it’s needed most. However, not all life insurance policies are created equal. Two common types are standard (or term) Life Insurance and Whole of Life Insurance, each serving distinct purposes. Below, we’ll explore the differences, and discuss how Whole of Life Insurance could be a game-changer for inheritance planning, especially with the changes coming to pension pots and inheritance tax in 2027.

What Is a Standard Life Insurance Policy?

A standard Life Insurance policy, often referred to as term life insurance, is designed to provide a payout if the policyholder passes away within a specified term, usually ranging from 10 to 30 years. If you outlive the policy term, there’s no payout. This type of insurance is often used to cover specific financial obligations, like paying off a mortgage or covering a child’s education.

Since it’s only active for a set period, it’s a more affordable option in the short term. However, once the term expires, the coverage ends, and there is no further benefit unless the policy is renewed or converted to a different type of insurance.

What Is a Whole of Life Insurance Policy?

A Whole of Life Insurance policy, as the name suggests, provides lifelong coverage. Unlike standard Life Insurance, a Whole of Life policy guarantees a payout whenever the policyholder passes away, regardless of age. This makes it an excellent option for long-term financial security, especially when planning for the future of your family or loved ones.

Whole of Life Insurance is typically more expensive than standard Life Insurance because it provides coverage for the entire lifetime of the insured, ensuring a payout. The policy doesn’t expire, so as long as premiums are paid, beneficiaries will always receive a death benefit.

The Whole of Life Insurance and the new Pension & Inheritance Tax (IHT) rules

As of April 2027, unused pension pots are likely to become part of your estate for inheritance tax (IHT) purposes. This means your pension savings could be taxed if your total estate exceeds the £325,000 threshold (or £500,000 if it includes a primary residence). For many, this could push them into the ‘million-pound’ inheritance tax bracket, resulting in a 40% tax bill on the excess.

Previously, pension pots sat outside of the estate, providing a way to pass wealth onto the next generation without IHT. However, with the new rules, this tax-free status is set to change, and those relying on their pensions as an inheritance strategy may face an unexpected tax burden.

How can Whole of Life Insurance help?

This is where Whole of Life Insurance could be the key to maintaining your inheritance strategy. By using some or all of your pension pot to buy an annuity (a guaranteed income for life), you can then use that income to fund a Whole of Life Insurance policy. The policy can be written in trust for your beneficiaries, which means the payout will be exempt from inheritance tax – just as pensions used to be.

In this arrangement, when you pass away, your beneficiaries receive the payout of the Whole of Life Insurance policy, which is equivalent to the amount of your pension pot (or however much you wish to insure). The key advantage here is that since the policy is in trust, it falls outside of your estate, and thus, avoids inheritance tax.

Why choose Whole of Life Insurance for inheritance planning?

A Whole of Life policy can offer several advantages for inheritance planning:

1. Lifetime Coverage: Unlike standard Life Insurance that expires, Whole of Life Insurance provides coverage for your entire life, ensuring your beneficiaries are protected no matter when you pass away.
2. Tax Efficiency: By writing the policy in trust, it falls outside your estate and avoids inheritance tax, even as pension pots are now included in the estate.
3. Inflation Protection: Some Whole of Life policies can be linked to inflation, ensuring that the sum assured keeps up with rising costs, safeguarding the value of your legacy over time.
4. Legacy Planning: If you want to leave a lump sum inheritance to your children or grandchildren, Whole of Life Insurance can be a great way to ensure they receive the intended amount without the burden of tax.

Is Whole of Life Insurance right for you?

If you have a pension pot and other assets that might push your estate above the IHT threshold, Whole of Life Insurance can help preserve the legacy you’ve worked hard to build. This option is particularly valuable for those who have children or grandchildren they want to support financially, as it can be used to ensure they inherit the value of your pension pot without the heavy tax burden.

Additionally, while many people fund their Whole of Life premiums with their own savings, there’s also an option for children to help fund a parent’s policy. This can be a practical solution to ensure that IHT is minimized and the inheritance passed on is maximized.

Conclusion

The upcoming changes to pension and inheritance tax laws make it essential to consider how you’re planning to pass on your wealth. If your pension pot was previously an ideal way to do this tax-free, it’s time to reconsider and plan accordingly. Whole of Life Insurance offers a powerful and tax-efficient alternative, providing both peace of mind and financial security for the future.

If you’d like to learn more about how Whole of Life Insurance can fit into your inheritance planning strategy, consult with a financial advisor. At Macbeth, we offer expert advice to help you protect your legacy for the next generation.

Please note: Estate Planning is not regulated by the Financial Conduct Authority.