Is life insurance taxable?

Life insurance is designed to pay out a lump sum of money to your beneficiaries if you die while the policy is still active. Lots of people take out cover to make sure their loved ones are looked after financially when they die. But is there any tax to be paid on the money received by beneficiaries?

The simple answer is no. There’s no income tax or capital gains tax on this lump sum payment. But it could be subject to inheritance tax (IHT), depending on how much your estate is worth and whether or not you’ve put the life insurance policy into trust. Your estate is the value of everything you own. The life insurance proceeds would form part of your estate if you haven’t put the policy into trust.

If there is any IHT to pay, it would be paid from your estate, not from your beneficiaries. The executor of your estate arranges to pay the tax to HM Revenue & Customs (HMRC). In the year to March 2025, the HMRC took £8.2 billion in IHT – an 11% rise from the previous year. And, with inflation and rising prices, more people are liable for inheritance tax every year.

When you die, your estate is the total value of everything you own, like your home, your car, your savings and any pensions, and any other assets. If altogether this is worth over £325,000, your estate could be liable for IHT at the current rate of 40%. This threshold rises to £650,000 for married couples and civil partners. 

If your life inheritance policy is put into trust, the lump sum payment will go straight to your beneficiaries and won’t be included in your estate. But if your policy wasn’t put into trust, the life insurance payment forms part of your estate. It’s then treated like everything else in your estate, so some or part of it could be subject to IHT at 40%. 

If the life insurance payout amount combined with all of your assets comes to less than £325,000, there would be no IHT to pay. 

Let’s look at an example.

• Your estate is worth £500,000 (£400,000 plus a life insurance payout of £100,000)
• When you pass away, you'll pay IHT on £175,000 (£500,000 minus £325,000)
• The amount of inheritance tax due is £70,000 (40% of £175,000)

The executor of your estate pays any IHT due from the estate to the HMRC.  

How the residence nil rate band can help

There are ways of increasing the £325,000 inheritance tax threshold. If you leave your main home to your child (including stepchildren, adopted and foster children) or grandchild, something called the residence nil-rate band (RNRB) comes into play. And this effectively increases the £325,000 to £500,000, as there’s a transferable allowance of £175,000. However, for estates valued at more than £2 million, this allowance decreases by £1 for every £2.  

There are pros and cons to putting your life insurance money into trust. Like anything else, whether it’s a good idea depends on your personal circumstances. A trust is a legal arrangement and you’d need to appoint trustees to manage it. You don’t need to set it up at the start of your life insurance policy – you can do this later on if you decide to. 

If you put your life insurance policy into trust, it means that any payout generally won’t be part of your estate so wouldn’t be liable for IHT. Because it won’t need to go through the probate process, the payout is normally paid out more quickly, too. However, one of the big downsides of a trust is that it can be difficult to make changes if you need to, for example if you marry or get divorced. 

Life insurance providers don’t generally charge to put your life insurance into trust, but it’s important to make sure it’s the right choice for you. Using a trust to avoid tax can be quite a complex area and there are various types of trust, all with different rules. When you’re planning for the future, it’s always sensible to get advice from a qualified financial adviser or solicitor to make sure the trust meets your needs. 

Will your estate be liable for IHT?

At the moment, most people in the UK don’t pay inheritance tax, as their estates aren’t worth enough. But this number is rising all the time and, with the average IHT bill standing at £215,000, it’s worth taking stock of your own situation. We always recommend speaking to a financial adviser who can take a holistic look at your circumstances and help you plan for the future.

Yes, you can. A life insurance policy that pays a lump sum when you die, like a whole of life policy, can be used to pay some or all of the inheritance tax bill. Some people set up whole of life policies (also known as life assurance) specifically to cover their IHT bills. 

You must pay inheritance tax within six months. If the policy has been put into trust, it won’t be part of the estate, and should be paid out quickly, so it could be used to pay some or all of the IHT. 

Is death in service benefit taxable?

Some people get death in service benefit through their jobs. This aims to provide your loved ones with a lump sum payment if you die while you’re working for your employer. It’s usually a multiple of your salary, like 3 times, for example. 

Death in service is generally held in a discretionary trust, so it won’t be part of your estate and there won’t be any income tax, capital gains tax or inheritance tax to pay on it. 

What happens to debt after death

Life Insurance payout times UK

Inheritance tax and how it works

Do you have to pay tax on other protection products?

Life insurance is by no means the only protection product that pays out a sum of money in the event of illness, injury or death. For example, critical illness, income protection and family income benefit are all choices to consider – but are these payments taxable?

Critical illness cover is often taken out as an add-on alongside life insurance. It’s designed to pay out a lump sum if you’re diagnosed with a serious illness during the term of the policy. The good news is that any payout you might receive for this isn’t taxed as it’s not considered to be income. 

Income protection policies pay a monthly amount if you’re off work because you’re ill or have been injured. The payments are tax-free if you pay the monthly premiums from your personal account, but you’ll be taxed if your company is paying for them as part of your benefits package.  

Family income benefit is a type of life insurance that pays out if you die during the policy term. But the difference from other types of life insurance is that your beneficiaries receive a monthly payment for the rest of the term, rather than one lump sum. This payment is tax-free. 

Some life insurance policies are tax deductible for your business, but by no means all. Personal life insurance premiums won’t count as a tax-deductible expense, but some policies can be. 

These kinds of life insurance policies could count as an allowable tax-deductible expense for your company:

• Death in service: This is a type of group life insurance generally aimed at large companies. If an employee dies while they’re working for you, the policy will normally pay out a lump sum to their chosen beneficiaries. It’s usually a multiple of their salary.
• Relevant life cover: Aimed at smaller companies, relevant life cover is often arranged for a small number of employees or for the director of a limited company. It can be taken out through the company, and will pay out a lump sum to the policyholder’s loved ones if they die during its term. 
• Key person insurance: This covers key employees, like the CEO or a particularly high-performing member of staff. The policy is owned and paid for by the company, and any payment will be paid to the company rather than the employee’s loved ones if they die. It’s there to help the business rather than the employee if something happens to their critical employees.   

If you’re not sure, it’s best to speak to a financial adviser to make sure you choose the right policy as they need to meet certain criteria to be an allowable expense.

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