If you have a life insurance policy (or are looking to get one) you may have asked yourself the question, would any life insurance payout be taxed?
However, it isn’t quite a straightforward answer.
In this guide, we’ll break down the details of how life insurance is taxed. We’ll also look at how you could prevent your policy from being taxed such as writing it in trust.
Is life insurance tax-free?
The first thing to understand is that when a policy pays out, the payout itself is tax-free. In other words, the beneficiaries (the individuals or people nominated to receive any payout if a claim is made on a life insurance policy in the UK) don’t have to (automatically) pay income tax on the money.
Whilst the payout in itself isn’t taxable, there may be circumstances where the beneficiaries have to pay tax on it. Although not subject to any specific ‘life insurance tax’, it could be considered part of your estate, which is subject to inheritance tax (IHT).
Your estate (otherwise known as your assets) can be passed down to your beneficiaries (loved ones, usually made up of family and friends). Your estate is the total sum of the things you own, including property (if a mortgage is fully paid off), vehicles, antiques, and anything else that you own (in full) to pass on to your beneficiaries. Your estate, however, could be subject to inheritance tax depending on the grand total of your estate/assets.
In the event of your death, your assets are taxable if they exceed the inheritance tax threshold which is currently £325,000 (2023/2024 tax year). So, if the total value of your estate exceeds £325,000, any amount above this threshold will be subject to 40% tax.
The total value of your estate is the sum of all your assets (however if the person who died owes money to other people, for example, on a credit card, for fuel, for rent or a mortgage, then this comes out of the estate). For further info on dealing with the financial affairs of someone who has died, please visit Citizens Advice.
Are life insurance premiums tax-deductible?
With a standard life insurance policy, you won't be able to claim tax relief on the premiums you pay each month. As premiums are considered a personal expense you must pay the full amount out of pocket without any tax deductions at the end of the tax year. This is where inheritance tax planning can come in handy.
What will be taken in inheritance tax?
Suppose you believe your beneficiaries are likely to owe inheritance tax on your estate after you die. In that case, it is important to calculate how much that tax bill might be when taking out a life insurance policy. The amount of the payout might not be enough if they also receive a large inheritance tax bill for your estate.
If you want to give any gifts away to your beneficiaries whilst you are still alive, they might still be subject to tax after you die if you gave them away within seven years prior to your death. So, it’s worth being aware that you won't necessarily avoid tax if you were to give away some of your assets before you pass away.
Already Have A Policy?
It’s great if you already have a policy in place, however, are you sure that it still meets your needs? Could you be getting a better deal? If you’re unsure, the team at Cavendish may be able to help get you a quote for a more cost effective life insurance policy.
Get A Quote Online Today
Once you’ve given this information some thought, it’s then really easy to arrange and compare online life insurance. Simply enter your details into our site and we’ll ask the questions we need to generate quotes, so you’ll be able to see what policy and options work out best for you.
Prefer to phone?
Sometimes, it’s easier just to give us a call and speak one-to-one with one of our insurance specialists, who can guide you through the process and support you in choosing the best cover for you and your loved ones.
Can I get tax-free life insurance?
If your life insurance policy is written 'in trust', any life insurance payout going into the trust will typically be exempt from inheritance tax because it's separate from your estate. It is widely understood that the majority of life insurance policies aren’t written in trust. This is likely due to a general lack of accessibility and awareness regarding trusts in general.
We have a page dedicated to writing your policy into trust to help you make informed decisions regarding putting your policy into trust. You can also speak to your insurer and ask them if you are able to write your policy into trust, they should be happy to help you.
What is trust?
A trust is a legal arrangement, under which the policy owner creates a legal framework (the trust) to hold assets for third parties. The three key parties to a trust are the settlor/s (those who own the policy), the trustees (who manage it) and the beneficiaries (who benefit from the trust).
The trust is run or managed by the trustees. It is then the trustees’ responsibility to ensure the beneficiaries receive the benefit of the policy, in the event of a claim. When you put a policy into trust, you effectively give it away to the trustees to look after the beneficiaries.
Usually, the Settlor (policyholder) will also be a trustee whilst they are still alive, so will retain some control, but any actions will need to be signed off by all of the trustees. So, make sure any trustees are people who will protect your interests in the long term.
Why do people put their policies into trust?
1. Inheritance Tax
The proceeds of a policy in trust may not be subject to Inheritance Tax.
2. Probate
The policy benefit does not go through probate when it has been written into trust and therefore can be paid out more quickly.
3. Protection
The policy benefits may have better protection from creditors of your estate should it be placed in trust.
Is life insurance tax deductible?
A standard life insurance policy isn't tax deductible, however, there are other policies where this is an exception. If you're a business owner, certain policies could be eligible for tax deductions under certain circumstances:
Key person life insurance
Key person insurance is a policy taken out by a business on the life of employees. The premiums paid on this kind of insurance can be deductible as a business expense for tax purposes.
Relevant life insurance
Relevant life insurance is a type of life policy designed specifically for employers looking to provide death-in-service benefits to their employees. This means that the company can deduct premiums from its taxable profits, while the employee receives the payout tax-free.
Already Have A Policy?
It’s great if you already have a policy in place, however, are you sure that it still meets your needs? Could you be getting a better deal? If you’re unsure, the team at Cavendish may be able to help get you a quote for a more cost effective life insurance policy.
Get A Quote Online Today
Once you’ve given this information some thought, it’s then really easy to arrange and compare online life insurance. Simply enter your details into our site and we’ll ask the questions we need to generate quotes, so you’ll be able to see what policy and options work out best for you.
Prefer to phone?
Sometimes, it’s easier just to give us a call and speak one-to-one with one of our insurance specialists, who can guide you through the process and support you in choosing the best cover for you and your loved ones.
You can call our team on
01392 436193
(Monday to Thursday 9am – 5.30pm, Friday 9am – 5pm)
