Plasmon resonant gold nanoparticles of various sizes and shapes have been extensively researched for their applications in imaging, drug delivery and photothermal therapy (PTT). However, their ability to degrade after performing the required function is essential for their application in healthcare. When combined with biodegradable liposomes, they appear to have better degradation capabilities. They degrade into smaller particles of around 5 nm that are eligible candidates for renal clearance. Distearoyl phosphatidyl choline : cholesterol (DSPC : CHOL, 8 : 2 wt%) liposomes have been synthesized and coated with gold by in situ reduction of chloro-auric acid. These particles of size 150-200 nm are analyzed for their stability, degradation capacity, model drug-release profile, biocompatibility and photothermal effects on cancer cells. It is observed that when these particles are subjected to low power continuous wave near infra-red (NIR) laser for more than 10 min, they degrade into small gold nanoparticles of size 5 nm. Also, the gold coated liposomes appear to have excellent biocompatibility and high efficiency to kill cancer cells through photothermal transduction. These novel materials are also useful in imaging using specific NIR dyes, thus exhibiting multifunctional properties for theranostics of cancer. © 2013 The Royal Society of Chemistry.