The Quick Answer
Life insurance payouts in the UK are not subject to income tax or capital gains tax. However, they could be subject to inheritance tax (IHT) at 40% if the payout forms part of your estate and your estate exceeds the nil-rate band.
The simple way to avoid this? Write your policy in trust. It is free, takes 10 minutes, and ensures 100% of the payout goes to your family.
Income Tax
A lump sum payout from a life insurance policy is not subject to income tax. Your beneficiaries receive the full amount tax free. This applies to term life insurance, whole of life insurance, and critical illness cover payouts.
Capital Gains Tax
Life insurance payouts are not subject to capital gains tax (CGT). This is because the payout is a benefit under a contract of insurance, not a capital gain from an investment.
Inheritance Tax – The One to Watch
This is where it gets important. If your life insurance payout forms part of your estate (because the policy was not written in trust), it is added to your total estate value. If the combined total exceeds the inheritance tax threshold, your beneficiaries could lose up to 40% of the amount above the threshold.
Current IHT Thresholds (2026)
| Threshold | Amount | Who Qualifies |
|---|---|---|
| Nil-rate band | £325,000 | Everyone |
| Residence nil-rate band | £175,000 | If passing main home to direct descendants |
| Combined (individual) | £500,000 | Homeowner passing to children |
| Combined (married couple) | £1,000,000 | Both thresholds transferable to surviving spouse |
Example
Sarah has an estate worth £400,000 (house, savings, pensions) and a life insurance policy worth £200,000 that is not in trust. Her total estate is £600,000. Using her £500,000 combined threshold, £100,000 is subject to IHT at 40%, meaning £40,000 goes to HMRC.
If Sarah had written her policy in trust, the £200,000 payout would not be part of her estate. Her estate would be £400,000 – below the threshold – and her family would keep the full £200,000.
Are Life Insurance Premiums Tax Deductible?
Personal life insurance premiums are not tax deductible. You pay them from your after-tax income. However, if you are a company director, a relevant life policy allows the company to pay the premiums as a tax-deductible business expense, saving up to 50% compared to personal cover.
Critical Illness Cover Tax
A critical illness payout is not subject to income tax, capital gains tax, or inheritance tax (when paid to you while alive). If you die and the policy pays out a death benefit, the same IHT rules as above apply.
Income Protection Tax
Income protection payouts that replace your income are subject to income tax because they are replacing taxable earnings. However, income protection premiums paid personally are not tax deductible.
Frequently Asked Questions
Not subject to income tax or CGT. May be subject to 40% IHT if not written in trust and your estate exceeds the threshold.
Write your policy in trust. This removes the payout from your estate, avoiding inheritance tax. It is free to set up.
Personal premiums are not tax deductible. Company directors can use a relevant life policy for tax-deductible premiums.
No. A critical illness payout is completely tax free when received while alive.