Life Insurance Tax Guide

Taking out a life insurance policy is one of the best things you can do to protect your family from falling into financial difficulties if you die unexpectedly, but what about the tax implications of life insurance? Could your loved ones be landed with an unexpected bill that could vastly impact the very purpose of your gesture?

In this guide, we explore the topic of life insurance and taxation. We take a look at the life insurance tax rules in the UK, and we’ll indicate where the experts we work with can advise you on getting the best plan in place for your family.

Click on each topic for more:

FAQs:

If you have questions about your UK tax situation when it comes to life insurance, talk to one of the experts we work with. Call 0808 189 0463 or make an enquiry for a free, no-obligation chat.

All the experts we work with are experienced, independent financial advisors. We’ll match you with an advisor who specialises in life insurance and tax planning. They’ll be happy to answer all your questions and find solutions where you need them.

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Do you have to pay tax on a life insurance policy?

The short answer is that elements of life insurance are taxable in some situations but not in others. This can be a complicated topic to get to grips with, which is no doubt why so many customers have asked us this very question.

When is life insurance taxable in the UK?

So, how is life insurance taxed in the UK? It’s entirely possible to have life insurance and not to incur any tax whatsoever, but in certain instances, payments related to life insurance do attract the attention of the taxman.

For example:

  • If any interest has been earned on the lump sum during the period between the death of the policyholder and the transfer to the beneficiaries.
  • If your policy includes some element of investment. This is known as a ‘non-qualifying’ policy – speak to an expert about your options if you think this may apply.
  • If the beneficiary is classed as an ‘estate’ rather than an individual and the total value of the estate exceeds the inheritance tax (IHT) threshold (currently £325,000).

If any of the above apply, the tax due falls on the nominated beneficiary or beneficiaries. There are a few, less common examples of situations where tax is incurred on sums related to life insurance – this is generally where an exchange takes place, such as a ‘life settlement’.


How much is life insurance taxed?

Any taxable elements of a life insurance payout above the IHT threshold will be taxed at 40%, or the current IHT rate.

There are several strategies that you can undertake to avoid saddling your dependents with this cost.

You could, for example:

  • Leave it all to a spouse or civil partner
  • Put the money in a trust, which will not attract IHT
  • Dedicate a portion of your money towards paying the IHT

If the lump sum you intend to pass on has incurred interest, the beneficiary will be responsible for reporting this as they would any other interest received in their tax return. The amount they pay on it will, therefore, depend on their total income.


Is life insurance taxed when paid out?

As the above examples illustrate, whether a life insurance payout is taxed will depend on the type of policy, whether or not the lump sum goes to an individual or to an ‘estate’, the relationship of the benefactor and beneficiary, and in some cases, the amount received.

If you’re due to be the recipient of such a payment, or if you want to ensure a sum you wish to leave to your family is handled in the most tax-efficient way, please don’t hesitate to get in touch and we’ll put you in touch with a suitable expert.


Life insurance tax FAQ

In the following section we’ve pulled together some of the questions we regularly receive from customers relating to tax on life insurance.

This isn’t an exhaustive list, so if you have any further questions or want to discuss the specifics of your own situation, don’t hesitate to contact us and we’ll put you in touch with an accredited life insurance specialist.

Is life insurance tax deductible?

Unfortunately, payments you make to a life insurance policy are not treated as an allowable business expense, so you can’t claim them as part of your annual tax return. If you were to do this, HMRC would be entitled to a portion of any payout, which would defeat the object of any claim.

Do you have to pay taxes on life insurance settlements?

If you decide to sell all or part of your life assurance policy to a company in exchange for cash, the amount released will be viewed as a taxable gain and you will be required to report and pay the tax. The actual amount of tax due is potentially complicated, and you will need to take specialist tax advice in this situation.

Am I eligible for life insurance tax relief?

In certain relatively rare cases, you could be eligible for life insurance tax relief. This is limited to those who took out a particular type of policy before 13 March 1984, when Life Assurance Premium Tax Relief (LAPR) was available with caveats on certain policies. Speak to an expert if you think this might apply to you. Make an enquiry for a free, no-obligation chat.

Are dividends on life insurance policies taxable?

If you have a type of life policy called a ‘participating policy’ you will be entitled to receive dividends. These payments do not usually attract income tax, but you might be obliged to pay tax on any dividends that exceed the total premiums for your policy.

Is employer life insurance taxable?

If you have life insurance through your workplace (often called ‘death in service’ benefits or ‘group life insurance’) you as the employee won’t normally have to pay any tax on the cover itself, as it isn’t classed as a ‘benefit in kind’.

The good news for any beneficiaries is that group life insurance is usually written into a trust, so any payout would fall outside your estate, meaning they won’t owe any inheritance tax on it.

Is life insurance surrender taxable?

Life insurance ‘surrender’ is the relatively rare act of giving up your life policy in exchange for a cash lump sum. If you surrender a policy in exchange for cash, this will be treated as income by HMRC, so you will need to report and pay tax on it at your usual rate.

Do you pay taxes on life insurance proceeds?

‘Life insurance proceeds’ is another way to describe a life insurance payout, so please refer to the section above ‘ Is life insurance taxed when paid out?’ for details.

What are the tax advantages of life insurance policies?

The tax treatment of life insurance policies depends on whether they are ‘qualifying’ or ‘non-qualifying’ policies, and this determines the nature of any tax advantages.

For example, a gain on a qualifying policy is generally not taxable, while those on a non-qualifying policy will attract tax due to the investment element of these products.

However, with a non-qualifying policy, you can withdraw up to 5% of the amount invested with no immediate tax liability, every year before the policy reaches maturity. We recommend speaking to an expert on how to make the most of these advantages.


Speak to an expert on life insurance and taxation today

Do you have any further questions about the tax implications of life insurance, or are you looking for the right life cover for you and your family? Call us today on 0808 189 0463, or fill out the enquiry form and we’ll be in touch soon to match you with an advisor for a free, no-obligation chat.

All the expert advisors we work with are experienced, independent financial advisors.

We'll match you with your perfect financial advisor

Save time and money with an expert who specialises in cases like yours

We'll match you with your perfect financial advisor

Save time & money with an expert who specialises in cases like yours.

We’ll match you with your perfect financial advisor – for free.