Is critical illness cover a taxable benefit?

This content was reviewed and approved by Geoff Eaton and Fiona Robson.

What is critical illness cover?

Critical illness cover is a type of insurance that typically pays out a tax-free lump sum if you’re diagnosed with a serious illness that’s listed in your policy.

Critical illness cover usually covers conditions like cancer, heart attack and stroke plus more — you can find the full list of illnesses and conditions in a provider’s policy documents.

The purpose of this lump sum is to give you some financial breathing space at a time you might need it most.

It’s up to you how you use a pay out in the event you have a valid claim. You might use the money to supplement or replace lost income if you were working, pay for private treatment, adapt your home to help things like mobility, or cover everyday living expenses while you undergo treatment and during recovery.

Unlike life insurance, which pays out on death, this cover is designed to support you during life-changing medical events.

Depending on the provider, you may be able to take out critical illness cover on its own or combine it with a life insurance policy. Some people opt for joint life, where both lives are insured, and to ensure their family is protected in all possible scenarios.

LV= offer critical illness cover as part of their life insurance options – so why not take a look?

What are the tax implications of a critical illness payout?

In most personal cases, the lump sum you receive from a critical illness policy is tax-free.

That means if you’ve paid the premiums yourself - either directly or as part of a life and critical illness combined plan - you won’t owe any tax on the money you receive.

However, there are exceptions. If your employer has paid the premiums or you’re receiving cover through a company scheme, tax may be applied either when the policy is set up, on the premiums, or on the payout itself.

As a general rule, for personal policies paid for with your post-tax income, you won’t need to pay Income Tax or Capital Gains Tax on the lump sum you receive.

How can you take out critical illness cover?

There are several ways to set up critical illness cover. The route you choose can have different tax implications, so it’s worth having a look at the most tax efficient options for your circumstances.

These include:

1. Personal critical illness cover

This is the most common route. With personal cover, you take out a policy directly with an insurer and pay the premiums from your personal income.

You choose the level of cover and how long you want the policy to last. When you receive money from personal cover schemes, you typically don’t pay tax on the lump sum payout.

2. Joint life and critical illness cover

Joint life insurance policies cover two people under one policy, with one premium. While typically taken out by couples, you do not have to be married or in a civil partnership to share a joint life insurance policy. It typically pays out on the first person to suffer a critical illness or pass away.

Premiums are paid jointly, and payouts are still typically tax-free if held personally.

3. Group critical illness cover (employer-provided)

Some employers offer critical illness cover as part of their broader benefits package.

With employer-provided packages, the premium is paid for by your employer, which could have tax implications for you depending on how the benefit is treated by HMRC.

4. Business-funded critical illness cover

If you're a limited company director, you may look at different types of cover that let employers offer a death-in-service benefit to their employees - which helps to protect their families financially should the worst happen and they are diagnosed with a critical illness.

While critical illness cover isn’t usually included in many life insurance plans, some providers offer business protection policies that cover critical illness. The tax treatment will usually be different when compared to cover you personally take out yourself, especially when premiums are paid by the company.

In what circumstance might critical illness cover be taxable?

While most critical illness cover payouts are tax-free, there are a few scenarios where tax can apply. Here are the key ones with real-world examples to help explain:

1. Employer-funded critical illness cover

If your employer pays the premiums for a critical illness policy that you own yourself, HMRC will usually classify this as a benefit in kind. This means that:

• You could be taxed on the value of the premiums your employer pays.

• The payout could also be taxed through PAYE if the benefit is classed as income at the time of claim.

For example, someone receives critical illness cover as part of their work benefits package. Their employer pays the full cost of the policy, and when they make a claim following a cancer diagnosis, the payout is processed via payroll, and Income Tax is deducted automatically.

2. Business protection policies for company owners

If you’re a company director of a limited company and your business pays for the cover to protect you or a key person in the business, there may be tax implications depending on how the policy is structured.

If the company is both the owner and beneficiary, and the policy pays out to the business, that money will usually be subject to Corporation Tax.

For example, if someone runs a small marketing agency and takes out a key person critical illness policy for himself, paid for by his business. They then suffer a serious illness and the policy pays out to the business, the money is considered business income and will be taxed accordingly.

3. Payout forms part of a deceased person’s estate

If the insured person dies shortly after a critical illness claim (and the payout hasn’t been used or passed on), the money may form part of their estate. In these cases, it could be subject to Inheritance Tax (IHT) depending on the size of the estate.

For example, if someone receives a critical illness payout, but passes away from an unrelated cause three weeks later, the money from the payout remains in their bank account but is counted as part of their estate. Because the total value of the estate exceeds the inheritance tax threshold, some of the payout may be subject to IHT.

Are critical illness premiums tax deductible?

In most personal cases, no - critical illness cover premiums are not tax deductible.

If you’re paying the premiums yourself, you won’t be able to claim any tax relief or offset them against your income tax bill.

However, there are some exceptions for limited companies and business owners:

• If your company takes out a critical illness policy specifically for business purposes like covering a key employee, and the policy meets HMRC's criteria, the premiums might be allowed as a business expense.

• Unlike certain types of life insurance, critical illness cover rarely qualifies for tax advantages under business arrangements.

Always seek financial advice and speak to a financial adviser if you’re looking to structure cover through your business - it’s a complex area and depends on policy ownership, beneficiaries, and the reason for the cover.

Need more information about critical illness cover as a taxable benefit?

Critical illness cover is designed to provide a lump sum payment if you're diagnosed with a critical illness, like cancer, a heart attack or a stroke.

This financial support can help cover everyday expenses, mortgage payments, or private medical treatment - giving you peace of mind during a difficult time.

If you're unsure whether this type of cover is right for you, our advisers are here to help. Get in touch today for cover tailored to your circumstances.