Are life insurance payouts taxable?
People use life insurance to make sure their families or dependents will receive cash benefits if they are no longer there.
Are life insurance benefits taxable?
When money is paid as part of a life insurance policy in the UK, the payout is not taxed, meaning the person or persons receiving the payment should not automatically pay tax on the money. However, although generally exempt from income tax, some life insurance benefits may still be subject to inheritance tax.
Life insurance and tax implications
Since life insurance benefits are considered part of your estate, which is subject to inheritance tax (IHT), your loved ones, the beneficiaries of your life insurance, might have to pay tax on the inheritance they received from you, including its life insurance portion. This inheritance tax depends on your financial situation at the time of your death and the size of your life insurance policy payout.
If you want to leave an inheritance for your family, chances are you will also want them to suffer from as little tax as possible on the inheritance you are passing on.
Tax numbers are always subject to change, but at the time of writing, if you are single, the current threshold for inheritance tax in the UK is £325,000, meaning that, if the total value of your possessions at the time of your death exceeds £325,000, any amount over £325,000 will be taxed at 40%. If you are married or in a civil partnership at the time of your death, each part of the couple has their own inheritance allowance of £325,000, meaning the couple will benefit from a total inheritance tax-free allowance of £650,000 and will only have to pay 40% tax on anything above that level.
If your life insurance payout was to take the total value your estate to a level in excess of the above threshold relevant to your situation, and unless the money is going to a charity, that excess value will be taxed at 40%.
Trusts for life insurance
However, there is an easy way that families in the UK can legally use to avoid having to incur inheritance tax liabilities on their life insurance payouts. To achieve this, they simply put their life insurance policies into a trust. If a life insurance payout is "in trust", it is considered separate from your estate and thus not likely to be subject to any inheritance taxes.
Trust means that someone else, be it your lawyer, family member or other trustee of your choice, is in control of the life insurance payout distribution from a legal perspective. This takes life insurance payout outside of your estate and thus outside of your tax liabilities. At the same time, you can still have the trustee follow your wishes when handling your life insurance payout. So the funds will be paid out the same way as you wish, probably even faster as the payment will not have to go through the estate inheritance tax and legal procedures.
When you talk to one of our FCA-authorised life insurance advisers, you can ask if you can buy your insurance policy in trust, they can certainly help and guide you how you can set it up.
Benefits of life insurance in dealing with tax liabilities
If a family's wealth likely to be transferred as inheritance is of a size exceeding the above thresholds (which would be the case for most property owners in the UK given the rise in average property prices over the last several decades), one of the important benefits of life insurance and putting it into a trust can be the support it provides to families who have to pay their tax bills on the inheritance received.
As life insurance payouts from trusts are exempt from inheritance tax, families can use life insurance as a very cost-effective and efficient mechanism to meet their tax liabilities on the estate that will arise on a family member's passing. Thus, senior family members can quite affordably help their loved ones to avoid having to sell off their inherited property or other possessions in order to meet the demands of the taxman they would have to deal with.
If you believe your family is likely to have to pay inheritance tax on your estate after your passing, it might be worthwhile to look into setting up a life insurance plan and calculate the amount of this tax before purchasing it. This will help you make sure your life insurance payout is at least sufficient to cover the potential tax liabilities for your loved ones and if you'd like to leave more than the taxman's share then go for some extra help for your family as your future policy payout.
Before taking any practical steps, it is always recommended to consult your own financial adviser who will be able to look into your specific situation and assist in making those decisions. Our FCA-authorised and experienced insurance experts can guide you in a friendly and free phone consultation as to what life insurance plans can be most suitable to your particular circumstances and life planning.
It takes less than 30 seconds to set up a free phone consultation with them to check how different plans from various insurance companies compare against each other and fit you best – just fill in a quick quote form on the button below and get a free, no-obligation quote from FCA-authorised life insurance experts!
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One of the most effective ways to protect family's finances
One of the best gifts one can make tax-free to one's loved ones, a financial legacy to help them cope
Many UK families still don’t realise that life, income protection and critical illness insurance is one of the most effective and efficient ways to protect their family's finances
Benefits offered by income protection, life and critical illness insurance
Life insurance, income protection and critical illness insurance are indispensable for every family because a child loses a parent every 22 minutes in the UK, while every single day tragically 60 people suffer major injuries on the UK roads. Some people become unable to work because of sickness or disability.Life insurance cover pays out a lump sum to your family, loved ones or whomever you choose to get the money. This can be used to secure the financial future of your loved ones meaning they would not have to struggle financially in the event of your death.
If it's a critical illness cover, the payout happens sooner - upon diagnosis of a serious illness, disability or medical condition, easing the financial hardship such an event inevitably brings.
Income protection insurance can be very important for anyone who relies on a pay check to cover their living costs, but it's especially important if you’re self-employed or own a small business, where your employment and income is a bit less stable. It pays a regular income if you can't work because of sickness or disability and continues until you return to paid work or you retire.
In a world where 1 in 4 of us would struggle financially after just four weeks without work, the stark reality hits hard – a mere 7% of UK adults possess the vital shield of income protection. The urgency of safeguarding our financial well-being has never been more palpable.
Let's face it – relying on savings isn't a solution for everyone. Almost 25% of people have no savings at all, and a whopping 50% have £1,000 or less tucked away. Even more concerning, 51% of Brits – that's a huge 27 million people – wouldn't last more than one month living off their savings. That's a 10% increase from 2022.
And don't even think about state benefits being a safety net. The maximum you can expect from statutory sick pay is a mere £109.40 per week for up to 28 weeks. Not exactly a financial lifeline, right?
Now, let's tackle a common objection: "But I have critical illness insurance. I don't need income protection too." Here's the deal – the two policies apply to very different situations. In a nutshell:
- Critical illness insurance pays a single lump sum if you're diagnosed with or undergo surgery for a specified potentially life-threatening illness. It's great for handling big one-off expenses or debts.
- Income protection, on the other hand, pays a percentage of your salary as a regular payment if you can't work due to illness or injury. It's the superhero that tackles those relentless monthly bills.
Types of life insurance policies
Common reasons for getting a life insurance policy are to:✅ Leave behind an amount of money to keep your family comfortable
✅ Protect the family home and pay off the mortgage in full or in part
✅ Pay for funeral costs
Starting from as little as a couple of pounds per week, you can do all that with a Life Policy.
Level Term Life Insurance
One of the simplest forms of life insurance, level term life insurance works by selecting a length of time for which you would want to be covered and then deciding how much you would like your loved ones to receive should the worst happen. Should your life insurance policy pay out to your family, it would be in a lump sum amount that can be used in whatever way the beneficiary may wish.
Decreasing Term Life Insurance
Decreasing term life insurance works in the same way as level term, except the lump sum payment amount upon death decreases with time. The common use for decreasing term life cover is to protect against mortgage repayment as the lump sum decreases along with the principal of the mortgage itself.
Increasing Term Life Insurance
Increasing term life insurance aims to pay out a cash sum growing each year if the worst happens while covered by the policy. With increasing term life cover amount insured increases annually by a fixed amount for the length of the policy. This can protect your policy's value against inflation, which could be advantageous if you’re looking to maintain your loved ones’ living standards, continue paying off your mortgage in line with its repayment schedule and cover your children’s education fees.
Whole of Life Insurance
Whereas term life insurance policies only pay out if you pass away during their term, whole of life insurance pays out to your beneficiaries whenever this should happen. The most common uses for whole life insurance are to cover the costs of a funeral or as a vehicle for your family's inheritance tax planning.
Family Income Benefit
Family income benefit is a somewhat lesser-known product in the family of life insurance products. Paying out a set amount every month of year to your beneficiaries, it is the most cost-effective way of maintaining your family's living standards to an age where you'd expect them to be able to support themselves financially. The most common use would be for a family with children who are not working yet so are unable to take care of themselves financially.
Relevant Life Insurance
Relevant Life Insurance is a tax-efficient policy for a director or single employee. A simple level term life insurance product, it is placed in a specific trust to ensure its tax efficiency. The premiums are tax deductible and any benefit payable should a claim arise is also paid out tax free, which makes it an attractive product for entrepreneurs and their businesses.
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No one knows when exactly they need life insurance, and when they do, it might be too late
This is why it is worth getting life insurance as soon as possible
As with other financial decisions in life, it pays to start early. Speaking to experienced FCA-authorised advisers is one of the best steps you can take to secure a great insurance plan for your family with minimal hassle