Ferromagnetic powder particles coated with electrical insulating inorganic layers constitute composite materials used as powdered iron cores in electromagnetic applications. The aforementioned surface layers of these soft magnetic composites (SMC) are responsible for their high electrical resistivity. The perseverance of the coating through annealing processing step is crucial to the performance of finalized SMC products. In the present study, the thermal stability and microstructure of an iron phosphate based surface layer from a commercially available SMC powder were investigated by coupling various analytical techniques. The material was annealed at different temperature regimes, both in oxidizing (air) and inert (N2) conditions in order to isolate the effect of temperature from the atmosphere composition on the chemical state of the coating. X‐ray photoelectron spectroscopy (XPS) was utilized to assess the composition of the surface layer at all conditions. Moreover, phosphate‐based chemical standards were processed and analyzed in a similar manner so as to facilitate the interpretation of the observed XPS spectra from the SMC powder. High resolution scanning electron microscopy, energy‐dispersive X‐ray spectrometry and X‐ray diffraction were implemented in order to fully characterize the material under question. The results indicated the transition of the insulating layer from an amorphous state to fully crystalline under annealing in inert atmospheric conditions. Moreover, it was observed that phosphates are still present in the coating in mixture of valance states. Conversely, a thick iron oxide scale was formed under treatment in air, and no phosphorus signal was detected, indicating a total decomposition of the layer. Copyright © 2016 John Wiley & Sons, Ltd.