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Published 09 April 2024
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Is Life Insurance Taxable?

Life insurance is usually paid out tax-free. But depending on how much your estate is worth when you die, and whether or not your policy is in a trust, there may be inheritance tax (IHT) to consider.

If you’ve taken the time to work out the right cover amount to protect your loved ones, it might be good to know that there is no specific life insurance tax. The lump sum that your insurer pays out if you die during the policy term can usually go to beneficiaries tax-free.

But if the payout is part of your estate when you die, you may need to consider any potential inheritance tax bill.

Is life insurance a taxable benefit?

You don’t pay tax, such as income tax or capital gains tax, on a life insurance payout. So if your beneficiaries receive a payout from your policy when you die, tax won’t usually be deducted.

It gets a little more complicated if your estate is worth more than the tax-free threshold when you die. If this is the case, there may be inheritance tax to pay.

It’s also worth knowing that unlike general insurance for your car or home, you don’t pay insurance premium tax (IPT) on life insurance premiums.

Is life insurance inheritance taxable?

You may be charged IHT on a life insurance payout if the lump sum forms part of your estate and the value of your estate when you die goes over the inheritance tax threshold.

Let’s unpack that:

  • Your estate is the assets you leave behind when you die. This includes any money, property and other belongings. The value of your estate is the sum of all of these.
  • If your estate is worth over £325,000 when you die, which is the IHT nil-rate band, the IHT bill will be 40% on anything above that if it isn’t covered by allowances and exemptions. So if the life insurance payout forms part of your estate, your estate may pay IHT on it depending on what other assets you also have and who the money will be passed on to. The nil-rate band has been frozen at £325,000 since 2009.
  • If you put your life insurance policy in a trust, it won’t be included in the value of your estate when you die, when the IHT bill is calculated. So you won’t usually pay IHT on the lump sum payout.

If there is an IHT bill, the executor of your estate pays it to HM Revenue and Customs (HMRC) from your estate funds.

It’s worth mentioning that most people in the UK don’t have estates worth enough to pay inheritance tax. Figures from HMRC show that just 3.7% of people who died in the 2020/21 tax year were charged IHT. 

When there is an IHT bill, it can be substantial, though. The average IHT bill in the same tax year was £214,000.

IHT exemptions and reliefs

There are allowances that can affect when or if IHT is charged, including:

  • If you leave a property to your child, stepchild, foster child or grandchild and it’s part of your estate, there is a property allowance of £175,000, increasing your total IHT threshold to £500,000.
  • Married couples and civil partners can pass on £650,000 combined or up to £1 million (including the property allowance) after one partner dies.
  • If you leave anything over the £325,000 threshold to your spouse or civil partner, or to a community amateur sports club or charity, there is usually no IHT to pay.

» MORE: A guide to inheritance tax

Does putting my life insurance in trust have tax benefits?

One of the reasons you might put a life insurance policy in a trust is that it won’t usually be included in the total value of your estate when you die.

This means the lump sum payout may be sheltered from IHT and it won’t be included in your allowance, which may reduce your IHT bill.

But bear in mind that not all types of trusts are exempt from tax. For example, there is an inheritance tax charge on some types of trusts every 10 years, or if you transfer a policy in or out of a trust. A solicitor or financial adviser should explain this when you set the trust up.

If you are likely to have a high-value estate, you might want to consider a trust. There can be other benefits too, such as having control over how and when beneficiaries receive the payout. Most life insurance providers offer to put a policy in trust for free. Before you go ahead, consider the pros and cons, and know that it’s hard to make changes to a trust once it’s set up.

» MORE: How does a life insurance trust work?

Life insurance and tax: a recap

You can assume that:

  • Life insurance payouts are typically tax-free.
  • You won’t be charged insurance premium tax on your policy premiums.
  • You can put your policy in a trust if you want to help shelter a life insurance payout from inheritance tax or help reduce a potential IHT bill on an estate.
  • If your estate is worth less than £325,000 when you die, there will be no IHT to pay.

Just be aware that:

  • If your estate is worth more than £325,000 with the addition of a life insurance payout, there may be IHT to pay on the lump sum.

Trusts and inheritance tax can be a lot to get your head around. A solicitor or financial adviser can offer guidance, so you’re clear about how inheritance tax and using a trust might affect what you leave behind for your family. They may also be able to suggest ways to help reduce any potential inheritance tax bill.

» MORE: Does life insurance always pay out?

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