Do Beneficiaries Pay Taxes on Life Insurance?

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Taking out life insurance for the first time can come with a lot of questions, including whether you pay tax on life insurance. It is 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 they were appointed to look after the policy payout in the event of you passing away, or whether they are to receive some of the funds, paying tax on and inherited life insurance can be 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 explain how tax can 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 term and decreasing term life insurance. However, other types such as family income benefit will offer a regular income until the end of the policy term. It is important to decide what your loved ones would benefit from most.  

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 may use the money to pay off the mortgage, pay childcare fees or household bills, and everyday living costs.  

Are the proceeds from a life insurance policy taxable?  

The main form of tax that can affect the proceeds 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.

Here at Caspian, we have a dedicated Trust team who will be on hand to run through any queries you may have regarding inheritance tax on life insurance, and how to go about setting your policy into Trust to help mitigate this.  

Setting a Trust up through Caspian is free of charge for our customers. We will 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 payout in the event of you passing away.   

How are life insurance proceeds taxed?  

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.  

The amount of tax payable will take into consideration your nil rate band allowance, which is currently £325,000.  

Is life insurance part of a person's estate?  

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

Whether life insurance is part of an estate or not is down to whether the policy was written in 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 via a trustee who you will have appointed to manage the trust. If you have followed this route, the life insurance pay-out 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 be very helpful if your family needs financial support sooner rather than later.   If you have not written your policy in trust, then the pay-out will become part of your estate and dealt with accordingly.  

When setting arranging a policy through Caspian, your Protection Advisor will always discuss your Trust options with you and our team will help you to arrange this with you to mitigate any tax on your life insurance, along with ensuring your policy goes to the right people, at the right time.   

Can life insurance pay for inheritance taxes?  

Life insurance pay-outs can be used for a number of purposes, such as paying off the mortgage and other important bills. However, in some cases, you may be able to use the pay-out to pay an inheritance tax bill.  

If the policy was written in trust and the beneficiaries receive the pay-out separately to the estate, it could be used to offset inheritance tax. Whole of life insurance is typically used to mitigate inheritance tax. If your loved ones are hit with a bill, it needs to be paid before they can access the estate.   If you have any questions about policy pay-outs or types of life insurance, get in touch with our helpful and friendly team today.  

Please note that the guidance above does not constitute financial advice and may change depending on individual circumstances.  

Source: Gov.UK May 2020

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