Is a critical illness cover payout taxable in the UK?

Full answer

Critical illness cover pays a tax-free lump sum if you are diagnosed with one of the serious conditions listed in the policy, such as cancer, heart attack or stroke. When a policy is held in your own name and you pay the premiums from your after-tax income, HMRC treats the payout as a personal insurance payment rather than earned income. The lump sum is therefore free of Income Tax, Capital Gains Tax and National Insurance, no matter how large it is. You do not need to declare it on a Self Assessment tax return and it does not affect your Personal Allowance. The tax-free status also applies when the policy is written in trust, which can be useful for Inheritance Tax planning because a policy in trust means the payout falls outside your estate. If an employer pays the premiums for a critical illness policy as part of a group benefit scheme, the treatment can be more complex and the payout may be taxable, depending on how the arrangement is structured. Employer-paid premiums may also create a taxable benefit in kind. Business protection policies, such as keyman insurance, are treated differently again -- the premium may be tax-deductible for the company but the payout is assessable as business income. For personal policies, the key point is that the premiums are paid from income you have already been taxed on, so the benefit is not taxed again when it is paid out. You can spend the lump sum however you choose -- paying off a mortgage, covering medical costs or replacing lost income -- without any tax consequences. Use a budget planner to estimate how much of a lump sum you would need to maintain your lifestyle if you were diagnosed with a critical illness.

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