Will My UK Life Insurance Payout be Taxed?

Will My UK Life Insurance Payout be Taxed?

Legally there is a requirement to pay inheritance tax on life insurance payouts but not in all cases. There are certain conditions attached to that, whereby paying IHT will not always be expected. There are considerations such as: what is the value of the estate? Criteria may dictate that you don’t have to pay IHT at all.

If you hope to leave your family an inheritance, life insurance is a sensible, realistic investment for yourself and your family. But what will happen to the payout of your policy in the event of your death? When an insurance claim is judged to be successful, beneficiaries will usually receive the agreed amount as set out in a policy.

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With whole of life cover, there is a period of 2 years whereby if death occurs from anything other than accident, the family will get 150% of premiums paid. If death occurs by accident in the first 2 years 3 times the sum assured will be paid out. After 2 years only the sum assured will be paid out on death whether it is natural or accidental.

With term assurance, there is no qualifying period so if someone sets up a policy today and dies tomorrow, the full sum assured will be paid out. There is normally no income tax to pay (also includes capital gains tax) on a life insurance payout (providing regular scheduled income or a single payout). But 40% IHT (inheritance tax) can be deducted from a pay out (excluding a spouse or civil partner), if the estate total is more than £325,000.

When a life insurance policy is written in trust IHT can be avoided and it is legal if you choose to do so. (Prime recommends putting a life insurance policy in trust as soon as possible).


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When Life Insurance is Part of the Estate

A life insurance policy will usually be part of the estate of someone who has passed, so a large part of a payout of life insurance may be subject to IHT.

What is an Estate?

When a person dies everything they own in that moment is called their estate. An estate can include such things as cars, houses and property, money and personal possessions such as watches and jewellery. PLUS the money that comes from a life insurance policy. Leaving the family home to children or grandchildren will increase the IHT threshold from £325,000 to £425,000.

Calculating the Value of an Estate

Put simply, this is subtracting ‘value of liabilities and debts’ from the ‘value of the assets’. Cost of legal fees should not be included in calculations, thus,

  • Work out the total value of liabilities and debts: credit card debt, mortgages and loans fall under this category.
  • Make sure paperwork is accessible and stored safely away with accurate calculations. This information may be required by HMRC at a later date, so having this will make the whole process much more manageable.
  • Find out the total value of all assets including property, money, life insurance, possessions, gifts made during the 7 years prior to death.

Benefits – writing a life insurance policy in trust:

  • The sum assured will not be subject to IHT if it is not a part of the estate. There are two trust types and they are discretionary and absolute (beneficiaries will stay the same – permanent). A trustee will be required.
  • Payment is made to beneficiaries when a death certificate is made available. Waiting for a will and probate can take a long time, so when a policy is not written in trust, beneficiaries will have to wait a lot longer to gain access to estate assets. This can present big problems for loved ones who will need to continue with things such as paying household bills and mortgage payments.

Life Insurance tax thresholds

  • The IHT first threshold is currently £325,000.
  • Married couples and civil partnerships, can transfer the £325,000 between them if one of them dies, so the threshold can double up to £650,000.
  • The residence threshold means parents can avoid paying IHT on up to an extra £175,000. The house must be left to a child or a grandchild in the family though.

A Life Insurance Beneficiary Can Delay a Payout

The majority of life insurance payouts are allocated in a single amount. A beneficiary can opt to delay the process of receiving the payout straight away. Another option is to receive installments over a longer period of time. An insurer can charge Interest (%) on delayed payouts, and interest can be subject to tax.

When does inheritance tax have to be paid?

If you are the beneficiary of an estate, IHT has to be paid within six months of the policyholder passing. Interest is normally paid if the tax is not paid in time, and interest can accrue further. Smaller gifts can be exempt from IHT, but larger gifts given in the the 7 years prior to someone dying can be subject to being taxed. IHT on gifts is dependent on when the gift was bought and how much the gift cost.

life insurance payout

Is it possible to avoid paying inheritance tax?

Yes it is. Here are some ways you can reduce the amount of IHT that your beneficiary would otherwise have to pay.

  • Pay regularly into a pension instead of just a savings account
  • Send gifts to the value of £3000 each year to loved ones.
  • If a 10% donation to a charity is promised to a charity, IHT will come down from 40% to 36%

Remember if you set up a life insurance policy in trust, this will mean potential savings on IHT in the future.

Can I use life insurance to pay inheritance tax?

Taking out Level Term Life Insurance (written in trust) will mean that you can gift your nearest and dearest a valuable gift. If a policyholder dies 7 years following the purchase of that gift, this type of insurance will cover the inheritance tax bill for that gift.

If you expect beneficiaries will have to pay IHT when you die, it would be wise to apply for a Whole of Life Insurance policy (write this in trust).

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Prime Financial Solutions and Mortgages Services

If you need help with Life Insurance and any of the following, Prime can help – telephone 01942 665 436:


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Setting up a life insurance policy is a complex issue. At Prime you always have an exceptional FCA approved team of life insurance & mortgage specialists with you on your journey. We provide excellent one to one services tailor made to your own individual needs and we make your time with us hassle free – we do all the heavy lifting for you. Prime is proud of the reputation it has built over many years, and this is largely reflected through the positive reviews we receive on a regular basis from customers in Wigan and the UK, on Trust Pilot and online.

Perhaps you have questions you would like answers to? Like..is there a penalty for cashing out life insurance? How can you withdraw money from the cash value? How to surrender a policy? Our dedicated team of experts can answer any of your questions.

Life Insurance is the simplest, most popular and best way to ensure your family is taken care of in the event of your death. You can find out more about us here and if you need help with Life Insurance and UK Life Insurance Claims, Prime can help. Click here to Get a Life Insurance Quote or use our quick contact form. You can telephone our friendly dedicated team 01942 665 436