Is life insurance taxable?

Published  15 May 2023
   4 min read

This is a really good question and one that is often avoided as it's thought to be quite complicated, but it really is quite simple.  

If a payout is made on a policy, regardless of how much the payout is for, the beneficiary is entitled to keep every penny of it and doesn’t have to pay any proportion of it as income tax to HMRC.

There is no specific tax on life insurance when you buy a policy or when a claim is made. However, it is important to remember that in the event of a death claim, the value of your insurance policy may be subject to inheritance tax (IHT) if it forms part of your estate.

Inheritance tax  

So what is inheritance tax? It’s a tax on the estate of the deceased person after all debts and funeral expenses have been deducted. This includes all the property, money, assets, and possessions that this person owned when they died, although pensions are normally not part of the estate.

As of the 2023/24 tax year, you can leave up to £325,000 in your estate without paying any IHT. This is known as the nil-rate band. Anything over this threshold will be subject to IHT at 40%.

In certain situations, there is less or no inheritance tax to be paid. For instance, someone leaving their property to their children or grandchildren gets an additional £175,000 exemption before paying IHT. There are also exemptions for spouses, civil partners and leaving gifts to charity. You can find out more in our guide to inheritance tax basics.

Writing a policy into trust

Most life insurance proceeds form part of a deceased's estate, but writing a policy in trust can ensure that any proceeds will be held outside of an estate upon death, avoiding the need to pay inheritance tax or reducing the amount to be paid, and also making things more efficient and easy for your executors.

Placing a plan into trust will also mean that the money is paid directly to the trustees without probate delays (known as confirmation in Scotland) and by nominating beneficiaries the trust will make sure the money goes to the right person.

As an example, Mr Smith has left behind an estate worth £500,000 to his nephew, the tax will be £70,000 (40% on £175,000 – the difference between £500,000 and £325,000.) If this plan had been written in trust, the proceeds would be outside of Mr Smith’s estate and therefore not subject to IHT charges.

If the value of Mr Smith’s estate is below £325,000 then there is normally no IHT to pay, but it’s important that your legal representative will still need to report it to HMRC.

The importance of advice

Insurance companies will normally have trust documents which can be filled in. But trusts are legal documents and normally can’t be changed once they have been completed. Taking advice can help you understand how a trust would work and if it’s right for you.

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