Originally Posted On: https://www.iquanti.com/
Life insurance can be a great way to provide for your loved ones and ensure they won’t be financially burdened after you’re gone. But given how significant these death benefits can be, will some taxes need to be paid? In this post, we’ll explore how the IRS views life insurance and whether or not it’s taxable.
Are Death Benefits Taxable to the Beneficiary?
Generally speaking, no. Whether the proceeds were worth $10,000 or $1 million, they will not be treated like earnings and do not have to be reported on your federal income tax return (source).
Interest on the Death Benefits
There may be some taxes related to the death benefit if there’s a delay in payment and interest incurred. Before insurance proceeds can be paid out, the insurer must do their due diligence by requesting the death certificate and verifying the claim. During this time, the balance of the death benefits will be held in an account and interest will grow. The distribution of this interest portion is considered taxable by the IRS.
Things can get even more complex if the beneficiary chooses an alternate distribution method. Most insurance companies will allow you to break up the full death benefit into monthly payments that can last up to 30 years. These methods will often include a preset interest rate, and again, this portion of the distribution is considered taxable.
Estate Taxes
While the proceeds of an insurance policy may be income-tax-free, they may still be counted as part of your taxable estate for estate tax purposes. There are different levels for both federal and state assessments, so it’s best to look up the latest limits and determine if the estate qualifies.
Other Taxable vs. Non-Taxable Situations
Interest on the death benefits and estate taxes aren’t the only times you have to be concerned about the taxability of life insurance. Here are a few other instances:
Is the Cash Value of Life Insurance Taxable?
If you buy a permanent life insurance policy, then it will also include a cash value component. Depending on the type of policy, it may earn interest, dividends, or grow with the stock market. However, just like a retirement fund, any earnings that grow on top of the contributions from the premiums won’t be taxable right away. They will be tax-deferred until withdrawal.
What About Withdrawals of This Cash Value?
If you borrow against this cash value in the form of a loan, then just like your mortgage or any other loan, you don’t have to claim it on your taxes since you are technically obligated to pay it back. However, if you withdraw the funds directly, then it does count as taxable income.
What If the Policy is Cancelled?
If a permanent policy is canceled and some cash value remains after the fees, then any portion that was earned above and beyond the contributions made from the premiums will be considered taxable.
Are Life Insurance Premiums Tax Deductible?
No. Unfortunately, you do not get to deduct the cost of life insurance from your tax return. The only exception is if it counts as a qualified business expense.
The Bottom Line
Generally, a life insurance death benefit is not considered taxable to the beneficiaries. However, if any interest grows on top of these proceeds, it will count as taxable income. The same is true of any withdrawals that include earnings above the policy’s cash value from the premiums.
