Life Insurance and Tax | Money Saving Advisors
Understand how life insurance payouts are taxed and any inheritance tax implications for your beneficiaries.
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Protect your family without inflating your estate
Life insurance isn't just about what you leave behind - it's about how you leave it. That tax-free payout? It's only tax-free if it's handled the right way. Without careful planning, your good intentions might trigger a 40% inheritance tax (IHT) bill.
When payouts are tax-free - and when they're not
Life insurance payouts are usually free from income tax and capital gains tax. But IHT can catch some people out.
- No income tax or capital gains tax
When your life insurance pays out, your family won't need to pay income or capital gains tax on the lump sum. So if your policy pays £300,000, they'll get the full amount - no deductions. - Inheritance tax and your estate
If your life insurance payout pushes your total estate over the IHT threshold (£325,000), the amount of payout above that could be taxed at 40%. - Using a trust to avoid inheritance tax
You can write your life insurance policy "in trust" so it sits outside your estate. You can do this when you take out the policy, so the payout skips IHT completely.
Life insurance and tax relief options
Unlike pensions or ISAs, life insurance doesn't usually offer tax relief when you're paying premiums. But there are still a few ways tax can come into play.
- Relevant life insurance for business owners
If you're a company director or run your own business, you could use a "relevant life policy." Your business pays the premiums, which are a tax-deductible expense that saves on corporation tax. - Group life insurance through work
If your employer offers life insurance as a benefit (like "death in service"), there's usually no tax on the payout, and it often avoids IHT too - especially if it's set up with a discretionary trust.
Summing up
Is there such a thing as tax free life insurance? Yes, but the inheritance tax threshold can be a trap if your policy isn't in trust. Business owners have special options, and work perks might come with built-in tax benefits. With a little planning, you can make sure your loved ones get the full benefit of your cover - with no surprises.
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Frequently Asked Questions
Do I need to worry about inheritance tax on life insurance?
Not necessarily. Inheritance tax (IHT) only applies if the value of your entire estate - including property, savings, and your life insurance payout - goes over £325,000 (or up to £500,000 if you leave your home to direct descendants). If you're well below this threshold, IHT might not be an issue, and if your life insurance is written in trust, it won't count towards your estate's value.
What if I have more than one life insurance policy?
Having more life insurance policies can increase the value of your estate, which may increase your inheritance tax liability. Your beneficiaries might pay tax if the total payout exceeds the threshold. To work out how much life insurance you really need - and avoid becoming subject to IHT - use a life insurance calculator and consider placing policies in trust.
What's a trust, and how do I set one up?
A trust is a legal arrangement that allows someone else - called a trustee - to look after assets (like your potential life insurance payout). Writing your plan policy into trust means the money doesn't go into your estate when you die, helping to avoid inheritance tax and speeding up the payout process. Most insurance providers will offer the option to write your policy into trust when you take it out.
Is life insurance a taxable benefit if my employer pays for it?
If you have "death in service" life insurance through your employer, it's usually not treated as a taxable benefit-in-kind. That means you won't be taxed for receiving it. The premiums your employer pays are generally classed as a business expense and don't appear on your P11D form. Plus, the payout your family receives is often placed in a discretionary trust, which means it won't be counted as part of your estate for tax purposes.
Can I change a life insurance policy to be in trust later?
Yes, in most cases you can put an existing life insurance policy into trust after it's been set up - but the earlier, the better. Changing it later may involve more paperwork and could affect how your policy is treated if you get ill or pass away before the change. Some older policies may have restrictions, so it's best to speak directly with your insurer or a financial advisor.
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