Life insurance policies have historically been offered as an effective tool for reducing the tax burden at the time of inheritance. In their traditional form—with guaranteed capital—this function was clear: upon death, the amount is paid to the heirs quickly and smoothly, protected from any claims.
However, the proliferation of financial policies (in particular unit-linked policies) has introduced the same volatility as the stock markets into the “insurance box.” In fact, these products behave more like investments than insurance, partly because market risk is not transferred – as recognized by recent case law, which is not always favorable to their exemption from seizure.
In addition to the market risk itself, there are two combined aspects that can make unit-linked products very penalizing in generational transfers:
- They cost more than pure financial products, eroding capital growth over time
- Redemption takes place when the policyholder dies: therefore, if the markets are falling, the loss is crystallized and the heirs cannot postpone the taxation of capital gains and leave the capital invested.
This second point is decisive: those who inherit large sums (and use a policy to avoid paying inheritance tax, which is only due on amounts above €1 million to direct heirs) often have no immediate need for liquidity. In such cases, the capital could continue to work on the markets, delaying the 26% tax on capital gains with enormous advantages.
That is why we have simulated the true opportunity cost in the long term.
The simulation
Initial capital invested: €2 million
Horizon considered: 15 years until death + 10 years after death
Average annual costs (derived from Ivass and Esma):
- Unit linked: 2.9% (RIY)
- Equity mutual fund: 2.1%
- Equity ETF: 0.6%
Assumed gross return on equity markets: 6% per annum
Capital gains tax: 26%
Inheritance tax (above the exemption): 4%
How much will the heirs receive after 15 years?
Instrument Net inherited value What happens from a tax perspective
| Tool | Inherited net worth | What happens from a tax perspective |
|---|---|---|
| Equity ETFs | € 4.308.147,80 | The 4% inheritance tax is already deducted here, but not the capital gains tax, which is deferred. |
| Equity funds | € 3.443.115,10 | As above |
| Unit linked | € 3.182.119,96 | immediate taxation of capital gains, no inheritance tax |
The life insurance policy is already the worst option here before considering the long term: because the amounts reinvested will now necessarily be lower than the alternatives.
If the heirs keep the capital invested for another 10 years
Let’s imagine that the heirs have a further ten years before they regain possession of the inherited funds/sums: how does the result change by reinvesting the life insurance policy, compared to leaving the funds or ETFs where they are? Quite a lot. The worst result overall? Reinvesting the liquidated unit-linked policy in equity funds, which after 25 years produce a total of €3,887,477.49 net of tax: over €2 million less than the best option. This is practically a gain that exceeds the amount originally invested 25 years earlier.
| Scenario | Net value with all taxes (25 years total) |
|---|---|
| Direct ETF | € 6.211.726,58 |
| Direct funds | € 4.437.529,09 |
| UL → ETF rebalancing | € 4.393.531,44 |
| UL → reinvestment funds | € 3.887.477,49 |
In conclusion, financial life insurance policies cannot prevail over alternatives in terms of performance or tax convenience, which is negligible if the combined effects of compound interest and deferred taxation on capital gains are taken into account. The advantages of unit-linked policies remain the speed of settlement, the personalization of beneficiaries, and other insurance features that relate more to non-financial needs than to returns. However, the financial cost of these advantages is likely to be very high.
