Asking whether life insurance is taxed does not have a straightforward answer, and the way that you have structured your life insurance policy or beneficiaries will have an effect on the tax implications of your life insurance payout.

The short answer, however, is that beneficiaries won’t pay income or capital gains tax on life insurance payouts that they receive from a policyholder. Here’s what you need to know about tax and life insurance.

Are life insurance payouts taxed?

For income tax and capital gains tax purposes, life insurance pay outs are not taxable. However, life insurance pay outs do have an impact on your estate and estate duties.

When it comes to understanding how tax and life insurance works, Craig Baker, CEO of MiWayLife,  says "When no beneficiary is nominated, the payout will form part of your estate and the estate duty calculation will determine the tax payable. With no beneficiary nominated, the life insurance payout will increase the value of your estate - which could also increase executor fees payable."

If a beneficiary is nominated, the life insurance payout will be a deemed asset in your estate. The deemed asset won’t increase the value of your estate for the purpose of executor fees but will be taken into account for estate duty. If you don’t nominate a beneficiary, it makes your estate amount bigger, and could increase executor fees.

“However, it is important to note that the deceased’s estate isn’t liable for the full amount of payment of estate duty due to SARS if the proceeds of the policy were paid to a beneficiary (other than the estate).

Estate duty will be apportioned between the beneficiary and the deceased’s estate,” says Baker.  

This means that if there is money due to SARS as part of the estate duty, the beneficiary of a life insurance payout is liable to pay in their share. How is each share decided? The executor of the estate will determine how much the beneficiary will be responsible for paying towards the estate duty.

Is the interest on a payout taxable?

Yes, if you inherit a sum and it gains interest in the bank, the interest will be taxable in the hands of the beneficiary as it is earned on the capital received. The same will go for any return on investments that you make with the payout.

How does the estate duty tax work?

Estate duty will apply to people that own an estate that starts at 3.5 million and above. For example, if you own an estate to the value of 3.5 million rand, the estate duty will be payable at a rate of 20%. Estates that are below the R3.5 million are not subjected to this tax. This will have to be paid within a year of the death date of your loved one. In such scenarios it will be advisable to speak to a tax specialist to see what applies to your situation.