Is life insurance taxable? 

A life insurance policy can offer peace of mind by helping to protect your loved ones when you die. 

However, you may be wondering if your beneficiaries have to pay tax on any payouts. We reveal whether your life insurance is taxable and whether you can legally avoid paying tax.  

Summary 

• Life insurance will pay a lump sum if you die while you have the policy. 

• A lump sum could help your loved ones during a tough time, but they may have to pay inheritance tax. 

• However, by planning ahead, your beneficiaries may legally avoid paying inheritance tax. 

• Unbiased can connect you to a qualified insurance broker or financial adviser.  

What is life insurance?  

A life insurance policy will pay out a lump sum if you die during the policy term.  

While it can be uncomfortable to consider life insurance, it can offer financial support for your loved ones, which is particularly important if you’re the main earner in your family. 

With a life insurance payout, your beneficiaries can cover essential costs associated with your death, such as funeral expenses, or use it to clear outstanding debt, such as mortgages or loans.  

You should ensure you name any beneficiaries on your life insurance policy and regularly review this, so the right people receive the payout. 

Life insurance payouts: how they work 

As we mentioned, life insurance policies usually offer a lump sum if you die during the policy term.  

This differs from other types of insurance, such as income protection or family income benefit, which can offer a regular income for a set period (or until retirement for the former).  

When you’re considering life insurance, it’s worth exploring your options, including the policy type, payout and premiums. 

An insurance broker can look at your unique circumstances to recommend the right policy for you. Unbiased can quickly connect you to a qualified insurance broker who can help.   

Are life insurance payouts taxed? 

As life insurance is designed to support your loved ones financially during a difficult time, the last thing they want to worry about is paying taxes. 

First, it’s important to stress that any beneficiaries won’t pay income tax on any payouts as this is paid on your earnings. 

However, your beneficiaries may have to pay inheritance tax (IHT) on any payout from a life insurance policy if it’s deemed part of your estate. 

The standard IHT rate is 40% and applies to the value of your estate if it’s worth more than £325,000. Your beneficiaries only pay IHT on the part of your estate that’s above the threshold. 

For example, if you have a life insurance payout of £150,000, after IHT (if this applies), this will fall to £90,000.  

There are some scenarios where you can pass on assets without paying IHT, but avoiding inheritance tax on a life insurance payout requires planning. 

How can you avoid paying inheritance tax on life insurance? 

If you put your life insurance policy in trust, your beneficiaries won’t have to pay IHT as it separates the payout from your estate.  

So, the payout won’t be considered for inheritance tax as it’s not considered part of your estate.  

However, there is much to consider before putting your life insurance in trust, as there are many pros and cons. One of the biggest cons is that you’re no longer legally in control of the payout.  

You can choose someone to manage this payout on your behalf to your chosen beneficiaries.  

It’s wise to seek expert advice from a qualified financial adviser before contacting your insurance provider. Unbiased can quickly match you with a regulated financial adviser who can guide you through your options. 

Is life insurance seen as part of your estate? 

When someone passes away, their whole estate will be considered, including any properties, investments, money, cars and possessions. 

This means that a payout from a life insurance policy will usually be considered part of your estate — unless you put it in trust, which will separate it. 

If you put it in trust, you can choose trustees to manage and distribute a life insurance payout in line with your wishes.  

Putting your life insurance policy in trust can yield other benefits, including a quicker payout to your loved ones, as the probate process can be lengthy.  

Unbiased can quickly connect you with a regulated financial adviser who can help with estate planning and ensure you don’t pay more tax than you need to.