Is life insurance taxable?

Yes or no, depending on the size of your estate and the approach you decide to take.

The proceeds from a life insurance pay out are not liable to either income or capital gains tax.

However, generally speaking, they do form part of the deceased’s estate, which depending on its size, could be subject to 40% inheritance tax.

An estate includes any property, savings and investments, possessions in your name and importantly for us in this article your life insurance policy.

However, any money used to cover personal debt and funeral costs are exempt from your estate.

Let’s delve into the detail to help inform you how your loved ones can reduce tax and make the most of your selfless investment…

Writing your policy in trust is free and is available on most policies arranged through Reassured.

It involves signing your life insurance policy over to another individual (trustee/s) to act on your behalf, similar to an executor of a will.

As a result of writing your life insurance in trust, the proceeds avoid forming part of your legal estate and therefore aren’t subject to IHT.

There are other benefits too, most notably a faster pay out to your loved ones as they’ll not have to wait for probate to be granted.

If you have young children, you’re unlikely to want to give them access to substantial funds at a young age.

However, you can specify in the trust that you only want them to receive the funds when they reach adulthood.

Despite this saving, it’s estimated that only 6% of policyholders currently write their policy in trust^[2].

These thresholds may seem high and you may not think IHT is anything for you to be concerned about, however, it’s important to think ahead.

Whilst the average price of a UK property is currently £231,855^[3], considering how much house prices have increased over the last 20 years, it's not unfeasible that this value could rise to reach the IHT threshold in the near future.

When you pass away, it’s possible (and common) to pass all your assets to your surviving spouse along with any unused tax-free allowance.

Their estate will then only be taxed after they pass away. However, because effectively both estates have been combined, the new IHT threshold is £650,000.

No, the monthly life insurance premiums you pay are considered a personal expense.

Therefore, they're not regarded as an allowable business expense, so you can’t claim them as part of your tax return.

There are policies available which fall into the life insurance category, but which are by default not subject to IHT.

Critical illness cover (CIC) will provide a pay out if you fall ill with a condition covered by the policy.

CIC policies pay out whilst the policyholder is still alive and are therefore not subject to IHT. They offer a good way of protecting your income if you become too ill to work.

Another less well-known option is family income benefit.

Instead of paying out a single lump sum, family income benefit pays your loved ones a regular monthly income for the remainder of the term and is thus not subject to IHT.