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Life Insurance and Tax

The proceeds of life insurance, whether they are given out in a single lump sum or on a monthly basis, are tax-free.

However, there is an exception to this. Life insurance can not be taxed, but your estate can. The proceeds of the life insurance form part of your legal estate which can become subject to inheritance tax (IHT). How does this happen and how can you avoid paying IHT?

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In the UK, the inheritance tax is due on estates worth more than £325,000. This may seem like a lot but it is worth noting the rising house prices, especially in the South-east. As of March 2020, the average house price in the UK is £231,855, and this figure is rising.

The proceeds of life insurance are part of that person’s estate. So if the total value of your estate exceeds £325,000, then your life insurance will be liable for the tax. Even if you are not liable, the proceeds of the life insurance could push you over the limit.

How can I avoid the Inheritance Tax?

There is a straightforward step you can take to avoid life insurance inheritance tax and that is — setting up your policy in trust. A trust allows you to set aside your policy to benefit a specific person (or people). It will be managed by a trustee (or trustees) who will then look after it on behalf of your dependents until an arranged time.

Unlike regular life insurance, this is not restricted to the time you pass away. This means you get greater control over the timing of your life insurance, as it does not have to be given as soon as you die.

For example, married couples or people in a civil partnership could choose their spouse/civil partner to be the trustee on behalf of their children. Your spouse would then look after the policy until the children are old enough to look after the proceeds themselves.

Another benefit to putting your life insurance policy in a trust is that the money will probably be paid out quicker than regular life insurance. This is because the policy will be free from the legal tangles that can often come from the processing of an estate after death.

Learn more – Putting life insurance into trust

Why does writing a Life Insurance Policy in trust work?

When your policy is written in trust, you do not technically own it anymore – at least in the eyes of the law. It is now under the ownership of your trustees, which means it is not part of your estate either.

Can I change my mind afterward?

Once you have written your policy in trust and handed it over to the trustees, it is no longer yours to control. This is called an “irrevocable act,” and can not be taken back.

This is why it is important to make sure you go over what you want to be in your life insurance policy until you’re completely happy with it.

What type of Life Insurance should I get?

It can be daunting to pick which life insurance is best for you, especially when faced with so many options. We’ll break down the most popular options to make your choice easier.

The first thing to decide is how long you want the insurance to last. If you want life insurance for a limited amount of time, for example, 20 years, then term insurance is the best match for you. This is the most common type of insurance.

Term insurance will pay out a lump sum if you die within the term. If you pass away within the term then your loved ones will receive a pay-out. If you live beyond the end of the term then the policy will simply come to an end. People will take out term insurance to pay off a mortgage or to make sure their young children will be provided for until they come of age.

There are several different types of term insurance. First, let’s look at three main types of plans you can get:

  • Renewable – This plan allows you to renew your term insurance policy when it expires. This is useful as you will not need to go through another health check. Be aware that the money you pay (also known as premiums) can change.
  • Reviewable – With reviewable policies, your plan will be fixed for a set period. After this period ends your insurer can review it and your changed circumstances. The premiums may be changed.
  • Convertible – Convertible life insurance is where you start out on term insurance but with the option of switching to whole-of-life insurance later on down the line if your circumstances change.
  • Also important to consider is what type of pay-out you want your beneficiaries to get. Do you want:
  • A sum that shrinks as your debt is paid off – If you want the pay-out and the premiums you pay into your policy to decrease as you advance into the term, then decreasing term life insurance is the policy to go for. Many people choose this plan to sync with the repayments on their mortgage or any other debt.
  • A sum that grows alongside the cost of living – Some people choose to have their pay-out and premiums rise as the term advances and this is called increasing term life insurance. This is so the pay-out will maintain its value later on down the line, despite inflation.
  • A fixed sum –You might want your loved ones to have security and know exactly the amount of pay-out they will receive. This is where level term life insurance is the most appropriate option. The amount will stay the same throughout the years and payout the sum agreed if you pass away during the policy term.

There are also other options for arranging the pay-out, for example, a policy where your family will receive the money as a regular monthly income. This particular policy is called Family income benefit. It is worth having a look at all the policies available, as well as the main ones if you are not sure exactly what is right for you. This way you can ensure you get the plan that fits your priorities the most.


Finder.com – Life insurance statistics

Statista – Life insurance industry in the United Kingdom (UK)

iam|INSURED – Frequently asked life insurance questions

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Is it worth paying for life insurance?

Yes, if you’ve got children or financial dependents then you should have life insurance to protect them if you die. Martin Lewis and the Financial Conduct Authority recommend that you take out life insurance to protect your family and your home. Generally, life insurance premiums start from as little as £5 per month and will be cheaper for younger adults.

Common myths about life insurance:

  •  — Life insurance won’t pay out (pays out 98% of claims)
  •  — People with medical conditions can’t have life insurance
  •  — Life insurance is expensive
  •  — Savings can be just as effective as life insurance
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Is life insurance worth it? - iam|INSURED

What is the average cost of life insurance per month?

Based on recent research carried out, the average cost of life insurance is approximately £38 per month and the average level of cover is £152,000. Life insurance premiums also vary dramatically from one insurance provider to another and you can reduce your monthly premiums by shopping around.

Fundamentally, life insurance premiums vary depending on your age, health and the amount of cover that you need, starting from as little as £5 per month. You can also get life insurance to protect your family and your home against financial loss if you die.

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Average cost of life insurance - iam|INSURED

What does life insurance cover you for?

Life insurance is a monthly renewable ‘term insurance’ contract that pays out a cash lump sum or regular payments on death to your family or beneficiaries. Policies are most commonly used for family protection or mortgage protection for your loved ones if you die and your household income reduces, plus the additional issues of losing a parent or carer.

Traditional life insurance will not exclude any pre-existing medical conditions and will cover suicide after 12 or 24 months. You can also use life insurance for business protection purposes as well as tax-efficient business life insurance for directors or key people.

What are the disadvantages of life insurance?

The biggest and most common problem that consumers have with life insurance is the cost and the monthly premiums. This is the top reason for policy cancellations and why more people don’t take out life insurance to protect their family.

Another key disadvantage with life insurance is that it holds no investment value, nor can you cash it in. Life insurance works like any other traditional general insurance policy (e.g. car insurance, house insurance, pet insurance etc.), you pay a monthly premium and it will pay out in the event of a claim. Some people decide to use savings instead of taking out life insurance but you need to make sure that you have sufficient savings to cover the costs of death for your family.

Why do I need life insurance?

The fact is that nobody actually ‘needs’ life insurance, but it is strongly recommended that families and couples have cover to protect their loved ones in the event of death. Martin Lewis recommends life insurance and says “this is something that every parent, partner, or person with any other type of dependent needs to consider”.

Life insurance financially protects your loved ones if you die and pays out a cash lump sum to repay your mortgage, pay for school fees, replace lost income, and pay for regular outgoings. Mortgage life insurance is not linked to your mortgage debt so you can use it to pay off some or all of your mortgage.

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