Do beneficiaries pay taxes on life insurance?

Taking out life insurance for the first time can come with a lot of questions, including whether or not you pay tax on your life insurance. It's important to understand how life insurance works and how the pay-out is received, as this can give peace of mind to you and your chosen beneficiaries.

Whether it's because you are a policyholder (you have a life insurance policy), you've been appointed to look after the policy pay-out in the event of the policyholder passing away, or whether you have been named to receive some of the funds; paying tax on a life insurance inheritance is a key question that many people ask.  

A life insurance policy can ease the financial burden that comes from losing a loved one. Here at Caspian Insurance, we can help explain how tax could have an impact on your life insurance.

How do life insurance pay-outs work?  

Most life insurance policies will pay out a lump sum, including level life insurance, decreasing life insurance and critical illness cover. However, other types of life insurance policies such as income protection can provide a regular income until the end of the policy term or retirement (whichever is sooner). It is important to decide what type of pay-out your loved ones could benefit from most. This all depends on your circumstances but don't worry, that's why we're here. At Caspian, our friendly team of UK-based experts can help find the cover that's right for both you and your loved ones. 

The pay-out follows a successful claim on a valid policy, and it can be used for a number of different things. For example, your family could use the money to pay off the mortgage, keep up with childcare fees, household bills, and everyday living costs.  

Are the proceeds from a life insurance policy taxable?  

The main form of tax that can affect the pay-out of a life insurance policy is inheritance tax. This is usually payable on all assets that form part of your estate, which may include any potential life insurance pay-out.  

If you are hoping to mitigate any tax liability, you may want to consider placing a life insurance policy under trust. This will usually separate the pay-out from your estate and therefore will not be subjected to Inheritance Tax.

How can you get tax-free life insurance? 

To help ensure that your life insurance policy is not subject to inheritance tax, completing a trust form is essential. Having a trust in place ensures that the money from your life insurance policy goes to the people you want it to go to. The best way to make sure of this is to place your policy into trust.

Once your policy is placed into trust, it will then be kept outside of your estate and as a result can help mitigate inheritance tax. 

What about income tax?

Looking at your payslip at the end of the month and seeing how much tax has vanished from your wage is never a great feeling but luckily you don't need to worry about tax when it comes to your life insurance. 

Income tax is a type of tax you pay on your earnings. But don't worry, generally the pay-out from your life insurance policy will not be subject to income tax. 

How to place your policy into trust 

Here at Caspian, we have a dedicated, in-house trust team who will be on hand to run through your forms, saving you time. We can help answer any queries you may have about your trust forms and how setting your policy into trust can help mitigate inheritance tax.  

Setting a trust up through Caspian is free of charge for all of our customers. We can provide you with advice on which type is best for you and explain the legal jargon to ensure you are comfortable and understand what will happen to your life insurance pay-out in the event of you passing away.   

How are life insurance proceeds taxed?  

The pay-out from most life insurance policies is tax-free and the only tax you'll really need to think about is inheritance tax. Life insurance proceeds can be taxed differently, depending on the arrangements of the life insured. There are different types of trusts available, which may mean different taxation rules. 

Is life insurance part of a person's estate?  

A person’s estate usually includes material possessions, such as cars, jewellery, and your home. An estate also includes money, which is why the proceeds of a life insurance policy can be included in their estate.  

Whether life insurance is part of an estate or not is down to whether the policy was written into trust. By writing your policy in trust, you can ensure the proceeds of the policy are dealt with separately to your estate. The money will go to the beneficiaries (the people you want to receive the money) via a trustee (the person you have chosen to manage your trust). If you have followed this route, the pay-out from your life insurance policy is not usually subjected to inheritance tax.  

This could mean your loved ones receive the money quickly, as they do not have to go through probate to receive the pay-out. This could come in handy, especially if your family needs financial support sooner rather than later. If you have not written your policy into trust, then the pay-out from your cover could become part of your estate. 

When you take out a life insurance policy with the help of Caspian, your protection specialist will always discuss your options regarding trusts with you. We have a specialist in-house trust team who can discuss your trust forms in regards to your life insurance policy. Your trust forms will help ensure your policy goes to the people you want and at the right time too.