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Tax-efficient family income benefit

20/04/2017

Life insurance can provide a tax-free lump sum for your family when you die. However, a family income benefit policy offers an alternative that has extra tax advantages. How do they work?

Lack of savings

If you’re thinking about ways to provide for your loved ones, paying into a pension can secure a capital payment and income for your spouse and children should you die either before you retire or within several years of it. But if you haven’t had time to build up a decent pot of money in your fund, it won’t provide much income for your family and, worse still, HMRC will take a bite out of it before it’s paid. You could take out run-of-the-mill life insurance to top up the pension or you could go for a family income benefit (FIB) policy.

FIB Basics

An FIB is a term life assurance policy, and so isn’t really an alternative to a pension. But it can be a good idea if you haven’t yet built up a decent pension fund or savings. An FIB pays out a set amount if you die within the period covered by the policy. Usually this is in the form of monthly tax-free payments to your spouse or family. However, a lump sum payment can be built in, but there’s a tax advantage to regular income.

Tip. Opting for regular income paid to your spouse is more inheritance tax (IHT) efficient than payment of a lump sum, which would hike the value of their estate. It could also trigger or increase an IHT bill if they died before they had used the capital sum paid to them from the FIB or other life assurance policy.

Limited period

On the downside, an FIB only pays income for the term of the policy unlike a pension which is usually payable for life.

Example. A 25 year old takes out an FIB policy with the sum assured, i.e. the total amount payable, of £500,000. A week after taking out the policy he dies. His family would get £20,000 tax free for 25 years, i.e. a total of £500,000. But if he survived 20 years, his dependants would be paid £20,000 for five years, i.e. £100,000 in total. This means that the longer you survive, the less the FIB pays. Once the policy period ends, in this example 25 years, there will be no payout at all.

How much does an FIB cost?

The rate of FIB premiums depends on your age and state of health. The rate also varies according to the type of payout you want. Normally an FIB pays a flat amount for the period of the policy, as in the example above. But for a relatively small increase in premium they can pay an index-linked monthly payment. A premium for a 35-year-old man in good health would be around £14 per month for a 25-year FIB paying a tax-free sum of £15,000 per year. If you wanted the payout to be index-linked, it would cost around a further £1 per month.

Summary

An FIB isn’t an alternative to building up savings. But unlike these it won’t form part of your estate for IHT purposes and the income it pays to your family after your death is tax free. An FIB can be a useful stop-gap to protect your family financially while you are making your first million!