Do you pay tax on critical illness payouts?

Tax is not the most riveting of subjects, we know. However, when taking out any kind of life insurance product, it’s important that you are aware of the tax implications. 

When it comes to critical illness cover, the money you receive from a claim is not taxable. Good news, right? That’s not all you should know though - there may be instances where tax does actually come into the equation. Let’s talk through the basics.

Why don’t I pay tax on critical illness insurance payouts?

When you receive the money from your critical illness claim, these funds are not counted as your income. That’s why they are not taxable. You haven’t earnt this payout - it’s instead considered compensation for the money you may have lost as a result of being diagnosed with a critical illness. You purchased the cover and you pay the premiums, so as far as the taxman is concerned, the money was already taxed when you received your salary. 

That’s one of the biggest attractions with critical illness cover - and other life insurance products. In the vast majority of cases, you receive funds when you need them most without having to worry that the amount will be reduced by tax.

When is a critical illness payout taxable?

Just to confuse matters slightly, there are a few instances where a critical illness cover payout could actually be taxable. The first is if your critical illness policy is a benefit that you enjoy from your employer. Because your employer will be directly paying the premiums for it, tax will be due on any payout you get from the policy. The exception to this is if your employer seeks corporation tax relief on the cost of the premiums that they are paying. Regardless, you can expect any benefit that you receive to be taxed via PAYE.

If you and your employer are sharing the cost of your cover, it depends on how much of the premium you are paying for, and how much your employer is stumping up. If, for example, you’ve divided the responsibility half-and-half with your employer (they are paying 50% and you the other 50%), you will need to pay tax on 50% of any payout from the policy. In some cases your employer may be paying in as part of a group scheme and you will receive a tax-free payout.

Although here at Lifesearch we do not offer the types of plans with a cash in value, another instance where you may face tax is if you are considering cancelling your critical illness cover and the cash surrender value will be greater than the premiums that you have paid. In this instance, the difference will be taxable. 

It’s also worth considering what might happen if you have a combined life and critical illness policy and you pass away, with the life insurance proceeds becoming part of your estate. The relevant authorities may deem the insurance proceeds to be taxable if it should have been included in your estate prior to your death. The proceeds of a combined life and critical illness policy could become taxable if the life insurance proceeds are paid to the estate when there are no chosen trustees. 

It may also be taxable if a person can make a claim on their critical illness policy, but fails to do so quickly enough to receive the payout whilst alive. This would mean that upon death, the money would go to their estate and become tax applicable, with the heirs needing to pay. 

Although the answer is broadly that no, you do not pay tax on critical illness insurance payouts, you can see that the answer isn’t quite as straightforward as that in every instance.

Got questions? We’re not tax experts and would advise you to speak to a Financial Adviser or a qualified accountant on the matters of tax and how it affects your own circumstances - but otherwise we can help you take the next steps.