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Life insurance tax | Is life insurance taxable?

Kasey Cassells
Written by Kasey Cassells, Senior content editor

Edited by Marianne Curphey, Finance Writer, 19 October 2020

Fact Checked
Are life insurance payouts taxable? Our guide to life insurance tax outlines how to get tax free life insurance and compare quotes.
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Life insurance tax | Is it taxable?
Life insurance tax | Is it taxable?

Is life insurance tax-free? Although it is usually exempt from tax, some life insurance payouts can be subject to inheritance tax.

Read our guide to learn about life insurance and tax, and how to keep your life insurance tax-free.

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Are life insurance payouts taxable?

When a life insurance policy pays out money, the payout is tax-free. In other words, the person or people who receive the payout do not automatically have to pay tax on the money.

While the life insurance payout itself is not in itself taxable in the UK, in some circumstances the person who receives it may have to pay tax.

Who benefits from a life insurance policy in the UK?

Someone who receives a life insurance payout is known as a beneficiary. Beneficiaries are named on an insurance policy as the people who will benefit from any payout if a claim is made on a life insurance policy in the UK, and the claim is accepted and paid out.

People take out life insurance protection to ensure that their family or dependants have a cash payout should they no longer be around.

Do I have to pay taxes on money received from a life insurance policy?

When a life insurance policy payout is made in the UK, it's not taxed.

However, although a life insurance payout is not subject to any kind of specific life insurance tax, it could be considered part of your 'estate', which is subject to inheritance tax (IHT).

Your estate is the money, investments, pensions, assets, property and anything else of value which remains after your death.

Whether your family have to pay tax on the proceeds from your estate depends on your financial situation at the time of your death.

It depends on the total value of your estate and whether your life insurance is in a trust, whether a life insurance policy payout might be taxed before your family and loved ones get to use it. 

Read our guide to learn more about the rules on tax and life insurance, and how you can legally and safely avoid having any of your life insurance payout taxed.

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  • Life insurance payout taxable uk

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Will my life insurance be taxed?

In the UK after you die, your assets – otherwise known as your 'estate' – can be passed on to friends and family. 

However, your estate might be subject to inheritance tax depending on the total value of your assets and your personal circumstances. 

Your estate is a sum of the things you own, including property (only if you've paid off the mortgage in full), jewellery, investments, cars, and anything else that you have full ownership of that you have the right to pass on to somebody else.

These are considered gifts and upon your death they are taxable if they exceed the inheritance tax (IHT) threshold. The threshold is currently £325,000 if you are single. So if the total value of your estate is more than £325,000 then any amount above £325,000 will be taxed at 40%. 

If you are married or in a civil partnership at the time of your death then each part of the couple has their own inheritance allowance of £325,000 each. This means a couple will have a total inheritance tax allowance between them of £650,000.

The value of your estate is the sum of all your assets except for the money used to cover debts and funeral expenses. However, you may already have life insurance in place to help your family deal with funeral costs and financial commitments such as mortgage debt after you die.

The payout you get from your life insurance policy can add to the value of your estate, so if your assets are worth £200,000 and your insurance policy payout is £200,000, giving you a total of £400,000, you will have to pay inheritance tax on the value of your estate above the threshold. This is why a life insurance payout might be taxable in the UK.

How do I get tax-free life insurance?

If your life insurance policy is written 'in trust' it will be separate from your estate and will avoid any inheritance tax. Most life insurance policies are not written in trust, which means that if you already have taken out a policy, it's likely that it will be subject to tax.

However, you can resolve this fairly easily. If you speak to your insurer and ask if you can write your insurance policy in trust, they should be able to help you.

This essentially means that someone else manages your payout, and that, legally speaking, you are no longer in charge of the payout (which is why it would have been considered as part of your estate previously). However, you still have control over how it is distributed and who receives it.

Your trustee can be a solicitor or someone in your family, and they will handle your payout according to your wishes. There is no change in the basics of how the payout is managed when you write it in trust; it only means that legally you will not have to pay tax, as it is no longer part of your estate.

The money will be distributed the way you want it to be, and theoretically, your family should receive the money quicker as it does not need to be subject to the same tax and legal proceedings as the assets in your estate.

Putting life insurance money in a trust

When you put your life insurance payout in a trust it is exempt from inheritance tax because it's separate from your estate.

This trust is managed by trustees, who will be chosen by you. This can be a solicitor or family members. They can then distribute the money according to your wishes.

You may also want to write your life insurance policy in trust for a child in your family, who will only be able to access the money once they reach adulthood.

If you plan your taxes accordingly, you could even arrange for your life insurance payout to help pay the tax bill on your estate after you die. For example, if the value of your estate is above the inheritance tax threshold, your family will have to pay tax on that amount. Your life insurance payout will be exempt from tax and could be used to cover the tax bill on the estate.

If your finances are quite complicated then it is best you speak to an independent financial adviser to help you find a solution that works for you regarding taxes and your estate.

Calculating your inheritance tax

If you believe your family is likely to owe inheritance tax on your estate after you die, then it is important when taking out life insurance to calculate how much that tax bill might be.

Your life insurance payout is likely to go towards paying for debts, funeral expenses and possibly helping your family get by over the few months after you die. The amount of the payout may not be enough if they also receive a large inheritance tax bill for your estate.

First, if your life insurance policy is in trust then it will be exempt from tax. Secondly, calculate what your estate is worth and see if you will have to pay tax.

The average property price outside of London is almost half of the tax threshold, with London properties being around the same value as the tax threshold. So with this in mind, if you fully own a property then it won't be too difficult for your other assets to put you in the inheritance tax paying bracket.

If you want to give any gifts away while you are alive they might still be due tax after you die if you gave them away within seven years prior to your death. So just be aware that you won't necessarily be avoiding tax if you give away some of your assets before you die.

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*The life insurance comparison service is provided by ActiveQuote Ltd who are authorised and regulated by the Financial Conduct Authority (501109). Registered Office; Global Reach, Dunleavy Drive, Cardiff, CF11 0SN. By using this system you are agreeing to our Terms and Conditions and Privacy Policy Monthly price based on non-smoking 25-year-old with £100,000 cover for ten years, postcode CF11 0SN. Price accurate as of 26/10/16.

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