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Do I have to pay tax on my life insurance pay-out?

A life insurance pay-out is usually tax-free – that is, in most cases the person receiving it isn’t required to pay tax on it. However, there is an exception to this rule.

When a single person dies, their estate (everything they own in assets: property, possessions, investments etc.) is priced. If all of this is calculated to be worth more than £325,000, then a 40% inheritance tax rate applies to any amount above this figure.

Therefore, if a life insurance policy is included as part of someone’s estate, the lump sum will be subject to inheritance tax if the total comes to more than £325,000. So, if a property is worth £250,000 and the sum assured totals £100,000, then that already takes a person’s estate over the tax-free threshold.

However, some people choose for their life insurance policy to be written in trust instead. What this means is that they effectively hand ownership of the policy over to a board of trustees, so it ceases to be part of their estate. Therefore, any pay-out is exempt from inheritance tax.

The trustees can be made up of solicitors or family members, who will ensure the beneficiaries of a policy receive their pay-out as per the policyholder’s wishes. Furthermore, because a life insurance pay-out is then treated as separate from the estate, the payment process is typically much quicker – dealing with a person’s estate can, by contrast, take months due to complex tax and legal processes.

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