If you die during the term of your life insurance, the payout forms part of your estate. Your estate is the sum total of everything you leave behind.
If your estate amounts to less than £325,000, your inheritors pay no tax on it. But if your estate, including your payout, is higher than £325,000, they pay 40% tax on anything above that threshold.
You can avoid this by putting life insurance in trust. Doing this separates your payout from your estate so your beneficiaries get the full amount tax free. This is even if your estate is over the £325,000 UK inheritance tax threshold.
You’d be wise to do this if your mortgage is more than £325,000. If your payout is over the threshold, the tax you’d have to pay on it may mean it’s no longer enough to cover your mortgage. Putting your policy into a trust is a smart way to ensure it is.
Trusts also usually allow your beneficiaries to get their payout quicker. With a will, your payout may have to go through probate, which can take a long time. With a trust, it normally doesn’t.
Your beneficiaries can also avoid paying inheritance tax if:
- You leave your estate to your spouse, civil partner or a charity
- Your estate amounts to less than £325,000, even after your payout.
You can find out more about inheritance tax on the GOV.UK website.