Many people do not realise that they could face a tax bill when they receive a pay out from life insurance. In fact there is a selection of taxes that come with insurance proceeds and it is worth being aware of what they are and therefore how to avoid them.
Income tax only becomes an issue when the life insurance pays out a monthly sum that will take the recipient above the tax limit. It is important to note that all income will be added together to determine whether the recipient is above the tax limit and so that will not just be the insurance pay out but also any other income such as pensions, earnings, interest and things like that. Of course, the tax will only be on the money earned over the tax rate and so it might be wise to keep the income amount to below the tax limit in order to avoid paying it.
Inheritance tax is paid if the deceased estate is over a certain value. This will include any money left including the value of property, insurances and savings. It can be quite easy to reach this threshold when there is property involved and so it is wise to try to protect the beneficiaries from the tax on the life insurance.
There are several ways to do this. It can be put in a trust but this will need to be set up well in advance of the person dying for it to be considered valid. The ownership of the policy could also be changed, so although it pays out when that person dies there is someone else named on it, to pay the premiums and receive the payment. However, once this has been changed, it cannot be changed again.
If an insurance policy in joint names is involved that is jointly owned, then it is wise to ensure that if one owner dies, all ownership goes to the other. This will mean that the insurance will hold no value until that other person does as well. If you want it to pay out when the other person dies then it is probably better to have separate policies set up in trusts so that there will be no inheritance tax due on them.
Tax is a complicated matter and in some cases unavoidable. However, it is important to be aware of the circumstances when tax can be avoided so that money can be saved. It is not cheating the system if it is a legal way to do it and so it is wise to find out about it so that you can make sure that you do not pay tax unnecessarily.