Will My Family Have to Pay Tax on My Life Insurance Payout After I Die?

Learn how life insurance proceeds are processed, whether you need to pay any tax, how to set up a trust and pitfalls to watch out for with insurance tax.

So you die. (I’m sorry 😔)

But you have life insurance. (Great job! 🥳)

Will your family have to pay tax on that life insurance? (Let’s find out 🧐)

Usually, life insurance payouts, either lump sums or regular income payments, are not taxable. This means that your family will not have to pay Income Tax or Capital Gains Tax (CGT) on the money.

However, the payout will form part of your estate for Inheritance Tax (IHT) purposes. The entire pot of what you leave may be subject to IHT if it totals more than £325,000. If you have a property to sell, it’s quite easy to exceed this figure with the house alone.

Let’s discuss some more basics around life insurance and taxes.

What will my estate include?

Your estate includes your house, second properties, and the combined value of your possessions such as cars and jewellery. It also covers any financial increments such as savings accounts or life insurance payouts. IHT is levied at a rate of 40% on anything over the £325,000 threshold. However, recent changes in the rules say if you leave your home to your children or grandchildren, then this threshold increases to £425,000.

How to avoid IHT with a life insurance policy

Many people put their life insurance policy in a trust to avoid IHT. The policy is placed in the hands of beneficiaries who look after it for you. Because you no longer own it, the policy and any payout will not form part of your estate. It is therefore not subject to IHT.

How to set up a trust

This is not complicated, as most insurers offer this when the policy is taken out and doesn’t usually cost extra. If you already have a policy and it is not yet in a trust, you can do this at any time.

A trust allows you to specify who receives the money. This is not something the beneficiaries can interfere with or alter after you die.

A big advantage of a trust

One key advantage of a trust is that the contents are usually available more quickly than if it is part of an estate. When someone dies, all their financial arrangements are effectively frozen for some time. This can make it difficult when relatives are waiting for your estate. A life insurance policy as part of a trust, will bypass probate and pay out reasonably quickly.

For this to happen, all the insurance company will need is a death certificate to prove that you have passed. This is relatively easy to set up and can be done before you pass away.

Pitfalls to watch out for

  • In order to avoid any income tax liability, the insurance policy must fall within a category described as ‘non-qualifying’. In simple terms, this means that it is straight life cover, there is no investment element. A policy that does not fall within the non-qualifying classification, might result in a beneficiary being liable for income tax.
  • Beneficiaries will most likely not be liable for any income tax on a lump sum received but they may be liable to pay tax on any interest received.
  • The most common type of life insurance policy is referred to as term insurance. This will pay out a specified sum if you die within the term of the plan and will usually be a qualifying policy. These policies have variations and can be level or increase over the term. This is to reflect inflation and ensure that there is real value at the end of a long term, say twenty years. This does not pay out a lump sum to beneficiaries or dependents but instead makes regular payments in the event of your death.

Policies do vary in what the cover includes, so always drill down into the details before you buy. Look carefully at any tax implications before you purchase a life policy and seek advice if you are unsure. We are always available to answer questions and help you get set up with life insurance. So please, let’s tackle peace of mind, together.

Instagram icon

Safeguard your loved ones and write your free will today! ✍️ Write My Free Will

teal shape

FF Bequest Limited, trading as Bequest, is authorised and regulated by the Financial Conduct Authority with firm reference number 923791. You can check our authorisation on the FCA Financial Services Register by visiting the following website: register.fca.org.uk . We are registered in England and Wales, Registered office address: Founders Factory, Northcliffe House, London, United Kingdom, W8 5EH. Company Number 12367897.

Regulated by the Information Commissioner's Office (ICO) [ZA662891]. "Bequest" is trademark protected by FF Bequest Limited (UK00003452648). FF Bequest Limited is registered in England and Wales, No 12367897.

0203 916 5433

FF Bequest Limited, trading as Bequest, is authorised and regulated by the Financial Conduct Authority with firm reference number 923791. You can check our authorisation on the FCA Financial Services Register by visiting the following website: register.fca.org.uk . We are registered in England and Wales, Registered office address: Founders Factory, Northcliffe House, London, United Kingdom, W8 5EH. Company Number 12367897.

Regulated by the Information Commissioner's Office (ICO) [ZA662891]. "Bequest" is trademark protected by FF Bequest Limited (UK00003452648). FF Bequest Limited is registered in England and Wales, No 12367897.

Privacy policy
Terms of Use
Complaints
Cookies