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What is the effect of inheritance tax on life insurance?

Inheritance tax on your life insurance policy may reduce the amount beneficiaries receive as it imposes taxes on the policy's proceeds when the policyholder dies.


  • Life insurance payouts are subject to inheritance tax if not written in trust.

  • The estate threshold for inheritance tax is currently £325,000.

  • Anything above the estate threshold is subject to 40% inheritance tax, barring a few exceptions.

  • Unbiased can quickly find a financial adviser to help with life insurance and estate planning.

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What is inheritance tax?

Inheritance tax (IHT), sometimes called the 'death tax,' is a governmental levy on assets a person leaves behind when they pass away.

The tax allows the government to claim a portion of the deceased's estate, including money and property, before transferring it to their heirs.

IHT is typically calculated as a percentage of the total value of the deceased person's assets, though exemptions and thresholds may apply. 

While designed to generate revenue for public services, life insurance inheritance tax is often a source of concern for families as it may impact the wealth transferred to the next generation.

So, individuals should carefully plan their estate to minimise the impact of it.

How does life insurance work?

Life insurance is a monetary safety net for loved ones, with individuals paying regular instalments to an insurance company.

In return, the insurance provider commits to paying out a lump sum to beneficiaries upon the policyholder's death. 

Beneficiaries typically use this lump sum to help cover outstanding debts and funeral costs or to financially support dependents.

Additionally, policyholders can tailor their life insurance policies to cover their mortgages or as an income replacement when they pass away.

Choosing between whole life and term life insurance depends on your circumstances. 

Writing the policy in trust can exempt it from IHT to ensure the money reaches the beneficiaries.

Do you pay inheritance tax on life insurance?

If the policy is written in trust, life insurance disbursements are usually exempt from IHT.

This means the proceeds do not form part of the deceased's estate and are directed to specific beneficiaries of the trust. 

However, suppose the policy is not written in trust. In that case, the estate's total value might be subject to IHT if it exceeds the current threshold of £325,000.

So, it's essential to structure your policy carefully to minimise or avoid IHT on life insurance.

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Is a life insurance premium tax-deductible?

In the UK, most insurance policies, such as life insurance and critical illness cover, are generally excluded from the  income tax regime.

Policy premiums are not tax-deductible, and policy payouts are usually tax-free. This means that the funds received due to a claim are not subject to income tax.

However, it's essential to consider the specifics of each policy as some types of insurance, such as investment-linked policies, have tax implications. 

Is avoiding inheritance tax possible?

Careful estate planning can reduce inheritance tax. We look at the legal ways to do this.

Annual gift exemption

One way to avoid inheritance tax is to use your annual gift exemption. Each year, an individual may gift up to £3,000 without incurring IHT.

The donor can give the amount to one or more people, and any unused portion may be carried forward for one year.

The seven-year IHT rule

The seven-year IHT rule stipulates that gifts made more than seven years before the donor's death are generally exempt from IHT.

However, if the donor dies within seven years of making a monetary gift, it might be subject to IHT on a sliding scale.

It's recommended to stay up-to-date with changes in tax regulations, especially regarding thresholds.

It is recommended that you consult with a tax professional or financial adviser for personalised advice based on current tax rules and your circumstances.

Can you put life insurance in a trust?

Putting life insurance in a trust is possible, and doing so offers several benefits.

Placing a life insurance policy into a trust is called 'writing the policy in trust.'

Below are some advantages to consider.

Inheritance tax avoidance

A primary advantage of writing a life insurance policy in trust is that the proceeds are typically exempt from IHT.

This means the payout goes directly to the beneficiaries and is not considered a part of the deceased's estate, avoiding inheritance tax.

Faster payouts

Putting a life insurance policy in trust can expedite the payout process. Since the funds aren't subject to probate, you can provide swift financial support to dependents.

Control and flexibility

When a life insurance policy is written in trust, the policyholder can specify the disbursement of proceeds. This provides greater control for complex family situations.


Trusts offer privacy as they are separate legal entities., so the payout amount and beneficiaries are not included in public records.

Estate planning

Writing life insurance in trust is a common estate planning strategy.

It helps people ensure their assets are distributed according to their wishes while minimising the impact of IHT on their estate.

Seek expert financial advice

Life insurance is part of a policyholder's estate and subject to inheritance tax if not carefully planned. 

You can avoid inheritance tax and streamline the payout process by including life insurance in trust.

Another option is to give money annually as a gift within the threshold, but this could result in a tax bill if you die within seven years of the gift.

Given the complexity surrounding tax laws and writing policies in trust, talking to a financial adviser or an insurance broker via Unbiased for expert financial advice is worth considering.

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About the author
Our team of writers, who have decades of experience writing about personal finance, including investing, retirement and pensions, are here to help you find out what you must know about life’s biggest financial decisions.