A simples guide

Are life insurance pay-outs subject to income tax?

It might seem underhand, having to pay tax when you’re looking out for your loved ones, so what exactly are the rules when it comes paying tax on life insurance


Do I need to pay income tax on a life insurance pay-out?

The good news is, no, you don’t. But that doesn’t mean you can get away tax-free altogether, because whilst you won’t need to stump up for income tax, a life insurance pay-out could be subject to inheritance tax.

When someone leaves behind their worldly goods, their estate (or everything of value they leave behind) is valued. Everyone has a tax free amount on their estate which means that your estate won’t need to pay tax on anything up to that amount – for the current tax year (2016-2017) that threshold is £325,000. The amount above the threshold is subject to 40% tax.
For example, if your great aunt decides to leave you £350,000 then the inheritance tax bill will be £10,000 (40% of £25,000 which is the amount over the £325,000 tax free threshold).

Passing on your tax free allowance to your spouse

We know it’s not something you want to think about, but making sure you’re clear about what happens to any money left behind when your spouse passes away is vitally important; especially if you have children that you want to make sure are left financially independent.

So it’s useful to know that if the worst should happen then the un-used tax free allowance is transferred to the surviving partner. This means that when the surviving partner eventually passes away, their estate will only be taxed if the total amount is more than £650,000 (their own tax free allowance plus the already deceased partner’s).

It’s also worth knowing that from the 6 April 2017, every person will get a further £100,000 tax free allowance, this will increase to £175,000 by 2020-2021. However, this extra amount will only be applicable if the home is left to children or grandchildren. You can also pass this extra allowance on to your spouse so in theory a married couple could leave an estate to their children worth up to £1 million without being charged inheritance tax.

Can I avoid paying inheritance tax on any life insurance pay-outs?

Of course the whole point of having life insurance is to make sure those you leave behind are financially secure and to avoid inheritance tax you can ask to set up the policy ‘in trust’. It’s not complicated to do and your insurance provider should be able to help you do this. If you already have a life insurance policy, you might want to double check how it’s set out in order to avoid loved ones missing out on your hard earned assets.

By putting a life insurance policy in trust, you’re separating it from your estate, which means it can’t be included when it comes to totting up how much you have in total. Any assets in a trust will be overseen by ‘trustees’ who you can choose – all this means is that they’ll make sure the money you’ve set aside in the trust goes to who it’s supposed to. Trustees can be family members, friends or your solicitor (basically anyone you can trust – so choose wisely).


heart in hands
money jar

So, how does a life insurance pay-out actually work?

Life insurance is paid when you pass away. It can be paid out in one lump sum or it could be paid out in regular intervals – it depends on your policy. Worth noting that the policies on our site are lump sum only payments.

The amount of money paid out will depend on the policy and cover you’ve agreed on with your insurance provider. When it comes to choosing a life insurance policy use our handy guide to the different types of policies available.

Compare for lifelong reassurance

We know there are some things that get brushed under the carpet because nobody likes to talk about them, but life insurance shouldn’t be one of them. Protecting those you love is about giving them financial safety and security and having life insurance will give both, as well as giving you peace of mind.

It doesn’t have to be expensive either, the average policy can cost just £16.80* – less than a weekly take away or night at the local. So use our life insurance comparison service to find the right cover for you and your family.

If you have any questions, call our family insurance service for assistance. Just call 0800 072 1141 (Mon-Fri 8am - 8pm Sat 9am - 2.30pm)


* Based on online independent research by Consumer Intelligence from February 2016 where 50% of customers could achieve the premium quoted.

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