Will My Life Insurance Pay Out Be Taxed

Getting covered with life insurance will ensure that your loved ones and dependants receive a lump sum payment, a series of smaller payments, or even a monthly income in the event that you die unexpectedly – and the income they rely on, stops dead in its tracks.

But, even with the right level of cover, the question of will my life insurance payout be taxed is one that will make a big difference to your beneficiary’s pocket.

So what do you need to know about the effects of tax on life insurance before buying a policy?

Save money on your life insurance

Life insurance pay-outs and tax

Life insurance payouts are not subject to income tax as your monthly premiums have effectively, already been taxed from your earnings. But this doesn’t mean you can rest on your laurels when it comes to life insurance and other kinds of tax.

Life insurance inheritance tax

Life insurance Inheritance Tax (IHT) which is charged at a rate of 40% on all estates over £325,000 is the real stinger when it comes to life insurance pay outs, as suddenly your beneficiaries are inheriting your wealth ahead of schedule.

But there are ways and means of side-stepping life insurance inheritance tax.

Written in trust life insurance

The most common and bona fide method of Inheritance Tax mitigation when it comes to life insurance is to have the policy written in Trust.  This serves in ring-fencing the life insurance pay out from any other asset – such as your property, savings and valuables – that are to be distributed in your will.  This means the money will not be subject to IHT during the probate process. 

Opting for the ‘written in Trust’ option on the policy can also speed up probate which makes things less stressful and less expensive for those who you leave behind.

Having your life insurance written in Trust will also allow you to have the money managed by a Trustee until such a time as the beneficiary is intended to benefit. This might not be the same time as when you die. For example, the Trust may state that your spouse or partner should look after a sum of £30,000 on behalf of your child until they reach a stated age – say 18 or 21.

Read the small print

The problem is that only an estimated one–in-five life insurance policies on includes the option of writing your policy in Trust, so make sure you read the small print carefully.

At MoneySupermarket.com, you can compare life insurance policies from more than 100 different providers on the market. But, during your search, keep in mind that the cheapest deal may not always be the best value, particularly if the option of being written in trust is not included.