Is life insurance tax exempt? Although it is generally tax exempt, some life insurance payments may be subject to inheritance tax.
Read our guide to learn more about life insurance and taxation, and how to keep your life insurance tax-free.
Are life insurance claims taxable?
When a life insurance policy pays out money, the payment is tax free. In other words, the person or persons who receive the payment do not automatically have to pay tax on the money.
Although the payment for the life insurance itself is not taxable per se in the UK, in certain circumstances the person receiving it may have to pay tax.
Who benefits from a UK life insurance policy?
A person who receives a life insurance payment is called a beneficiary. Beneficiaries are named on an insurance policy as the people who will benefit from any payment if a claim is made on a UK life insurance policy, and the claim is accepted and paid.
People buy life insurance to make sure their family or dependents receive cash payment if they are no longer there.
Do I have to pay taxes on money received from a life insurance policy?
When a payment for a life insurance policy is made in the UK it is not taxed.
However, although a life insurance payment is not subject to any specific type of life insurance tax, it could be considered part of your “estate”, which is subject to personal income tax. estates (IHT).
Your estate is money, investments, pensions, assets, property, and anything else of value that remains after your death.
Whether your family has to pay tax on the proceeds of your estate depends on your financial situation at the time of your death.
It depends on the total value of your estate and if your life insurance is in trust, if a life insurance payment could be taxed before your family and loved ones can use it.
Read our guide to learn more about tax and life insurance rules, and how you can legally and safely avoid tax on your life insurance payments.
Will my life insurance be taxed?
In the UK, after you die, your assets – otherwise known as an ‘estate’ – can be passed on to your friends and family.
However, your estate may be subject to inheritance tax depending on the total value of your estate and your personal situation.
Your estate is the sum of the things you own, including property (only if you’ve paid off the mortgage in full), jewelry, investments, cars, and anything else you own and own. the right to transmit to someone else.
These are considered as gifts and on your death, they are taxable if they exceed the threshold for inheritance tax (IHT). The threshold is currently £ 325,000 if you are single. So if the total value of your estate is over £ 325,000, any amount over £ 325,000 will be taxed at 40%.
If you are married or in a civil partnership at the time of your death, each part of the couple has their own inheritance allowance of £ 325,000 each. This means that a couple will have a total inheritance tax abatement between them of £ 650,000.
The value of your estate is the sum of all your possessions except money used to cover debts and funeral costs. However, you may have already purchased life insurance to help your family deal with funeral costs and financial commitments such as mortgage debt after your death.
The payment you get from your life insurance policy can increase the value of your estate, so if your assets are worth £ 200,000 and your insurance policy payment is £ 200,000, this gives you a total of £ 400,000, you will have to pay inheritance tax on the value of your estate above the threshold. This is why a life insurance payment may be taxable in the UK.
How to take out tax-free life insurance?
If your life insurance policy is written “in trust”, it will be separate from your estate and will avoid any inheritance tax. Most life insurance policies are not written in trust, which means that if you have already purchased a policy, it is likely that it will be subject to tax.
However, you can fix this problem quite easily. If you talk to your insurer and ask if you can write your insurance policy in trust, they should be able to help.
Essentially, this means that someone else is handling your payout and, legally speaking, you are no longer responsible for the payout (which is why it would have been considered part of your estate before). However, you still have control over how it is distributed and who receives it.
Your trustee can be a lawyer or a member of your family, and they will handle your payment as you wish. There is no change in the way the payment is handled when you write it in trust; it only means that legally you will not have to pay tax because it is no longer part of your estate.
The money will be distributed as you want it to be, and theoretically your family should receive the money faster because it does not need to go through the same tax and legal proceedings as the assets in your estate.
Put the life insurance money in a trust
When you put your life insurance payments in a trust, it is exempt from inheritance tax because it is separate from your estate.
This trust is managed by trustees, who will be chosen by you. It could be a lawyer or family members. They can then distribute the money according to your wishes.
You may also want to write your life insurance policy in trust for a child in your family, who will not be able to access the money until they reach adulthood.
If you plan your taxes accordingly, you could even arrange for your life insurance to help you foot the tax bill on your estate after you die. For example, if the value of your estate is greater than the inheritance tax threshold, your family will have to pay taxes on that amount. Your life insurance payment will be tax exempt and could be used to cover the estate tax bill.
If your finances are complicated enough, it’s best to speak with an independent financial advisor to help you find a solution that’s right for you when it comes to taxes and your estate.
Calculation of your inheritance tax
If you think that your family is likely to owe inheritance tax on your estate after your death, then it is important, when taking out life insurance, to calculate the amount of this tax bill.
Your life insurance will likely be used to pay off debts, funeral costs, and possibly help your family cope for a few months after your death. The payment amount may not be enough if they also receive a large inheritance tax bill for your estate.
First, if your life insurance policy is in trust, it will be tax exempt. Second, calculate the value of your estate and see if you will have to pay taxes.
The average price of properties outside of London is almost half of the tax threshold, with London properties being roughly the same value as the tax threshold. So with that in mind, if you fully own a property, it won’t be too difficult for your other assets to get you into the inheritance tax payment bracket.
If you want to give gifts while you are alive, they may still be taxable after your death if you gave them within seven years of your death. So be aware that you will not necessarily escape tax if you donate part of your assets before dying.