Is Critical Illness Insurance A Taxable Benefit?

The quick answer: no, if you pay your premiums yourself and yes, if your employer is (part) paying it.  If you’re diagnosed with a critical illness, one thing of many you’ll need to get a handle on is your financial position, and if your critical illness claim payout will be subject to tax.

If it’s your policy that you pay it’s easy: no tax. If your policy is part of a corporate/ employee benefit package then yes, there’ll probably be tax.  

What are the tax implications of a critical illness payout?

• You pay for your own policy … in which case no tax 
• Your employer pays for your policy … in which case you’ll be taxed
• You and your employer split the cost of the policy … in which case you’ll be taxed only the portion your employer pays. 

Do you pay tax on your critical illness payout? 
 

If you pay for the critical illness cover 

If the policy is in your name and you pay the premiums then no, you aren’t taxed on critical illness claims. This is because you pay for it out of your take-home-pay, which has already been taxed. 

If your employer pays for your critical illness cover 

Some employers offer critical illness cover as a perk, benefit or incentive. That means they pay some or all of your premiums for you. In this instance, any cash that’s paid out will be subject to tax.  
There are certain ways your employer can reduce or offset that tax, but the headline is simply this: yes, you’ll be taxed. 

If you share the cost of your critical illness cover with your employer

If you and your employer share the cost of critical illness cover premiums (maybe they pay 50% and you pay 50%) then yes, it’ll be taxed; but only the portion you haven’t personally paid for. 

If you’ve contributed 50% of all premiums out of your own take-home pay, then that 50% of the claim is not taxed. However, the piece the company has paid for (the other 50%) will be taxable.  It’s most likely that tax will be taken at source/ through PAYE.

In what other circumstances might Critical Illness cover be taxable?

If you’re subscribed to an employer scheme, it’s very possible you pay your premiums pre-tax. In other words, the cost of your critical illness policy is removed from your gross pay (not net pay) so you pay less tax overall. 

This can add a small complication when claiming, but it’s nothing that can’t be explained by an expert before, during or after you explore life insurance and / or critical illness cover. 

Do I have to pay taxes on life insurance and critical illness payout?

In most cases no, but a handful of scenarios may crop up where life insurance and /or critical illness payouts will be subject to tax.  

Tax will be due if your policy has been paid for by your employer. And in some instances, your claim payout may be rolled into your estate when you die, thus it could be subject to inheritance tax. This could happen if:

• A critical illness claim is made; but you die before it is paid
• You don’t have named beneficiaries/ trustees on your life insurance policy
• You haven’t put your life insurance policy into trust, which could lock it “outside” of your estate 

Inheritance tax kicks in when your estate (the sum total of your assets such as property, cars, cash minus all outstanding expenses) is valued above a certain threshold - at present £325,000.  

If you’re above that number before you add a life insurance payout to the mix, inheritance tax of 40% kicks in. In that scenario, a life insurance payout of £100,000 will lose £40,000 to inheritance tax.

Do my beneficiaries have to pay tax on my life insurance? 

It depends on the set-up of your policy. If the life insurance lump sum is part of your estate, then it will be subject to inheritance tax, if your total estate is valued over £325,000. There are ways around this, such as putting your policy into trust to lock it outside of your estate.  

What is inheritance tax?

It’s a tax on a dead person’s estate.  For every £1 that person is worth (in property, cars and assets minus expenses) above a £325,000 threshold, 40% inheritance tax is due. That threshold of £325,000 is frozen and will not budge until at least 2028. 

If you die and the total of your estate (after expenses) is £500,000, you’ll be taxed 40% on £175,000 (the amount above the £325,000 threshold), so £70,000. 

Here’s a little more to help you understand inheritance tax...

Can I give money away to avoid inheritance tax? 

Yes, you can. If you arrange for at least 10% of your estate to be donated to charity, you’ll pay 36% inheritance tax (IHT) on some assets instead of the usual 40%. You can also gift away portions of your estate while still alive within certain limits.  

You can give away up to £3,000 in a single gift each year, and you can give away IHT-exempt donations of up to £250 to different people. You can gift £5,000 to a child as a wedding gift and avoid inheritance tax.  

You can avoid inheritance tax if you arrange to leave your entire estate to your spouse or civil partner. Relief is available if you decide to give your home to your children or grandchildren. 

We’ve noted only a few examples here, but inheritance tax is quite a dense and complicated subject. For further reading, why not start with Inheritance Tax and Life Insurance. 

Can I put my  life insurance ‘in trust'?

Yes - and you probably should. Putting your life insurance in trust should protect it from inheritance tax by locking it, legally speaking, outside of your estate. That means avoiding inheritance tax, but also tends to speed up the payout process.

The speed is to do with avoiding probate, the process of ‘proving’ the legal right to deal with a person’s estate and carrying out their wishes. Life insurance policies in trust can avoid this lengthy process.  

Are you paying towards your premiums without knowing it?

It’s possible you are (or have been) enrolled in an employer life insurance scheme without knowing. To find out, look at deductions on your payslip and ask questions of any items you don’t recognise. You could also get in touch with management or human resources.  

If you believe you could have a live life insurance policy, look at your bank statement for a monthly direct debit. Life insurance policies are deemed to be cancelled if you miss a payment or two, so the policy can only be valid if you’re still paying for it.  

Other articles on tax and insurance you might be interested in: 

Do you pay tax on your income protection payments? 

Understanding inheritance tax and life insurance 

Life insurance exists to protect you. And no two people are the same. The best policy for you depends on where you are, what’s going on at home, your health, your plans, your needs and your budget.

LifeSearch work with a wide range of top insurers so we can find perfect protection for unique you.