Will My Life Insurance Payout Be Taxed?

You might not consider yourself wealthy enough for your estate to be subject to inheritance tax (IHT). If this is the case, it might very well come as a shock to you that it doesn’t take owning a mansion or a fancy car for your death benefit to be subject to inheritance tax. In fact, if everything you own including your benefit amount comes to a combined value of £325,000, your family may be forced to pay 40% tax on your estate

So, for example, if you have a life insurance benefit that’s worth £60,000, you have a car worth £10,000 and a house worth £260,000, you’re £5,000 over the threshold and your family will be taxed 40% of your estate. That’s almost half of the entire value of your estate. 

The first step to tackling this problem is figuring out how it works. So, here’s the lowdown on IHT in the UK.

How does Inheritance Tax in the UK work?

Inheritance Tax is applied to the estate of someone who has passed away. An estate typically includes all property, money and possessions. Jewellery, vehicles, homes, even pets are included in an estate. Whoever inherits the estate must pay 40% tax on the entire value of the assets as long as it’s above the £325,000 threshold.

There is no IHT due if the total value of your estate is below the £325,000 threshold. Bear in mind that even if the estate’s value is below this threshold, you must still report it to HMRC.

If you’re married or in a civil partnership, and your estate is worth less than your threshold, the remainder of ‘unused’ threshold can be added to your partner’s threshold when you pass away. This means that their threshold can potentially be as high as £950,000.

I’m worried that my estate will be above the threshold

If you’re worried that the value of your estate will exceed the IHT threshold, there are ways to avoid IHT being owed on your life insurance payout. We’re going to run through two ways you can dampen the blow of IHT:

  • Dividing your estate with a Will
  • Placing your policy into a Trust

Write a Will

With careful planning, it’s possible to use a Will to spread your estate in such a way that it does not exceed the threshold. By leaving your estate to certain people or organisations, you can help prevent the final benefit amount from being taxed, potentially leaving your family in a financial rut. A Will can be used to legally divide your estate amongst your loved ones or certain organisations Let’s look at how this might work...

There is no IHT due if the total value of your estate is below the £325,000 threshold or if you leave everything above this threshold to your spouse, civil partner, a charity close to your heart or a community amateur sports club. If you leave your home to your children (that includes adopted, foster and stepchildren) or your grandchildren, the threshold increases by £475,000.

Place your life insurance policy into a Trust

By placing your life insurance policy into a Trust, you can protect the lump sum from inheritance tax regulations. Placing your policy into a Trust means using a third party who will ‘hold’ the policy and the benefit amount, making sure it reaches your beneficiaries when the time comes. A Trust allows you to manage your assets like money, investments, property and so on. 

What are the benefits of using a Trust? 

Not only is your payout protected, but your family will also have faster access to the money. When a life insurance policy goes through a Trust, it doesn’t have to be tallied up as part of your estate by the executor and there is no need for probate. This makes the entire process a lot smoother for everyone involved.

It’s important to know that if you’re placing your policy into a trust, it’s important to seek legal or professional advice. This is a precaution to make sure everything is set in stone and your benefit reaches the right people, at the right time. 

It pays to be prepared when it comes to IHT

If you feel your estate could be valued above the threshold, it could be worthwhile taking preventative measures like writing a Will or placing your policy into a Trust. If you don’t believe your estate will be valued above the threshold then you don’t have to make a Will or use a Trust.


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