Do beneficiaries pay taxes on life insurance?

Do I have to pay taxes on life insurance?

Life insurance payouts are usually tax-free, because unlike a person’s salary, dividends or business profits, they’re not taxed as income. However, the payout may be subject to inheritance tax if its value pushes the deceased person’s estate above the government’s inheritance tax threshold. 

Learn more: How to reduce inheritance tax

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Does life insurance get inheritance taxed?

Life insurance can sometimes be subject to inheritance tax depends. When a person passes away with a life insurance policy in place, the life insurance policy will form part of their estate. If the total estate is worth more than the inheritance tax threshold, the amount above the threshold will be liable for inheritance tax at 40%. 

The good news is that by planning ahead and getting advice from a financial specialist, you may be able to legally reduce your inheritance tax liability or perhaps avoid paying it at all. 

What is the inheritance tax threshold?

The current inheritance tax threshold is £325,000. This threshold (officially known as the nil rate band) is the total value of property, savings, investments and possessions a person can pass onto their loved ones tax-free when they die. 

There’s usually no Inheritance Tax to pay if either:

• Your estate is worth less than the £325,000 threshold
• You leave everything above this threshold to your spouse, civil partner, a charity or community amateur sports club

If your life insurance policy will push your estate over the threshold, you could protect the payout by placing the policy in a trust. Speak to a protection specialist like a member of our award-winning team before taking this step. 

Learn more: How much life insurance do I need?

Are life insurance premiums tax deductible?

Life insurance premiums can sometimes be tax deductible, but not always. If you’re self-employed or the director of a limited company, some forms of life insurance can be tax deductible. You may be able to claim life insurance as a business expense if you’re taking out relevant life insurance, death in service insurance, or keyman life insurance, for example. But you won’t be able to claim your life insurance as a business expense if you take out your own personal cover. 

How is life insurance paid out to beneficiaries?

Exactly how life insurance is paid out to beneficiaries can depend on the policy type (single or joint), whether the policy was placed in a trust as well as the trust’s terms. With a single policy placed in a trust, the payout will be paid to the surviving trustees, who will distribute it among the beneficiaries. With a joint policy placed in a trust, the payout will be paid to the surviving policyholder, but half of the payout will form part of the late policyholder’s estate. If both policyholders die, the lump sum will be paid to the trustees (the legal owners of the assets held in the trust). It’s their responsibility to use the assets in line with the late policyholder’s wishes. 

The trustees may need to distribute the life insurance payout among the beneficiaries. In some cases, the trustees may hold onto the payout themselves, using the money to care for the beneficiaries or keeping it safe until they’re in a position to use it. This type of arrangement is particularly ideal if the beneficiaries are under 18, elderly or vulnerable in some way. 

With a single policies not placed in a trust, the payout will form part of the policyholder’s estate and may be liable for inheritance tax. For joint policies not placed in a trust, the payout will be paid to the surviving policyholder, but half of the payout will form part of the deceased policyholder’s estate. If the policyholder passed away with a will, the lump sum will be distributed according to their wishes. If they passed without a will, the lump sum will be distributed by the state, usually to the closest family members. 

If both policyholders die at the same time, the younger policyholder is legally considered to have survived the older policyholder, meaning the money will form part of their taxable estate and may be liable for inheritance tax.

Learn more: Can I have more than one life insurance policy?

How long does it take for insurance companies to pay out to beneficiaries?

Life insurance policies tend to pay out a lump sum to beneficiaries once the claim has been approved. The claim process can take between 30 days to several months, depending on the policy and provider. The sooner loved ones get in touch with the insurance company following the policyholder’s death, the sooner they’ll have access to the money. Some providers will release a portion of the funds within 7 days so beneficiaries don’t need to use their own savings for funeral costs.