Is a critical illness insurance payout taxable in the UK?

Full answer

Critical illness insurance pays a lump sum on diagnosis of a specified serious condition such as cancer, heart attack, or stroke. The tax treatment depends on who owns the policy and who paid the premiums. Personal policies -- no tax If you take out and pay for a critical illness policy personally (premiums from your own after-tax income), any payout is not taxable. It is not subject to Income Tax, Capital Gains Tax, or National Insurance. HMRC does not treat it as income or a gain -- it is compensation paid under an insurance contract. Employer-paid policies Where an employer pays critical illness premiums for an employee, the premium is usually treated as a benefit in kind and is subject to Income Tax and Class 1A National Insurance via the P11D process. The payout itself, however, is still generally received tax-free by the employee because the employer is the original policyholder assigning the benefit. If the employer sets up a Relevant Life Policy or a group critical illness scheme, specific rules apply. Always verify the policy structure with the insurer or an adviser. Inheritance Tax considerations If the payout falls into your estate on death (unlikely for a living-benefit critical illness policy, which pays on diagnosis, not death), it could form part of your estate for IHT purposes. Writing the policy in trust is a common way to keep the payout outside your estate and ensure faster payment without waiting for probate. Business-owned policies Where a business takes out key-person critical illness cover, the position is more complex. HMRC may treat premium payments as non-deductible capital expenditure, and any payout received by the company would be a trading receipt subject to Corporation Tax. HMRC's Business Income Manual (BIM45500 series) sets out the tests applied. Practical points -- Premiums you pay personally are not tax-deductible against Income Tax. -- Payouts do not affect your Personal Allowance, tax code, or benefit entitlements in most cases (though means-tested benefits may be affected if the lump sum is held as savings). -- Placing a personal policy in trust is generally recommended for estate planning purposes. Always confirm the specific terms of your policy with your insurer and seek independent financial advice for complex arrangements.

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