Is life insurance taxable? | QuickQuote®

quick Facts

  • Life insurance itself is not taxable, nor is it a typical death benefit
  • There are rare instances in which a death benefit is taxable, such as when a person’s estate absorbs the death benefit
  • If you have a cash value life insurance policy, there are also some cases where that can be taxed as well.

The insurance market has always presented people with different choices when choosing a service provider, and with choices come questions. For example, a common question is whether or not life insurance is taxable.

Taxes are frustrating enough, so we want to take the guesswork out of whether or not there are taxes on life insurance. A life insurance policy provides financial stability to the designated beneficiaries of the deceased in the form of compensation. Many often wonder whether or not life insurance payments are taxable.

While there are differences between Types of life insurance policies Available And What You Will Get With A Whole Life Insurance Policy No life insurance policy is going to be taxable.

No matter what type of coverage you have, your beneficiaries will receive benefits at the time of your death. The payment is the amount of money that friends or family members named on your policy will receive at the time of your death. This amount is generally not subject to tax.

As in most cases, there are exceptions, but traditional life insurance payments are not taxed.

Are there taxes associated with life insurance payments?

Payments from a life insurance policy — sometimes called a death benefit — are often tax deductible, with some exceptions. Because beneficiaries do not have to claim death benefits as a source of income, they are tax-exempt in the eyes of the government.

So, you can use the death benefit to pay bills or cover time spent outside of work, which is separate from traditional wages. There are some exceptions, but the life insurance policy must clearly define these exceptions. It’s a good idea to familiarize yourself with the specifics of your policy because of these scenarios.

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When is life insurance payout taxable?

There is no such thing as a life insurance payment tax because the payments are not a source of income. However, the following situations will make the death benefit taxable:

The death benefit is paid by annuities

The death benefit is often paid in one lump sum, so if the amount in the policy is $10,000, the beneficiary receives the entire amount in one payment. If the beneficiary chooses to receive the payments over some time, it is then referred to as an annuity.

An annuity is an amount of money that is paid to someone over a period, usually annually. When the insured makes this choice, the insurer keeps the death benefit and pays it to the beneficiary in instalments. While the original return is still not taxable, the interest that accrues when it is with the insurance company will take away income tax.

Your estate absorbs the death benefit

Life insurance payouts will always be off limits to debt collectors, even if you own property. The amount goes to your surviving beneficiaries, so a death benefit cannot be used by anyone to pay off any outstanding debt that may exist as part of your estate.

However, assume your beneficiaries are no longer alive when the death benefit is paid. In this case, the death benefit becomes part of your estate along with everything else, which means that debt collectors have access to that money.

This scenario also depends on your net worth. Real estate taxes vary by state. According to the IRSreal estate taxes have seen some changes, including restrictions on the federal estate tax exemption.

More than two people participate

A death benefit is usually between only two people. The first person is the insured person who is also the owner of the policy. The second is the listed beneficiary.

There are examples where there may be three people involved. For example, if someone else purchases a life insurance policy for the insured, and the beneficiary is separate, the IRS will consider the death benefit a gift.

So if the insured person, the person buying the policy, and the beneficiary are different, the gift tax will be attached to the death benefit.

How should life insurance payments be used?

The advantage of life insurance payments comes from the fact that beneficiaries can use the money as needed. This means that unlike A Mortgage insurance policywhich can only be used against the mortgage of the property, the death benefit can go towards any of the following:

  • Pay any outstanding monthly bills paid by the deceased
  • Covering work missed during the grieving period
  • Pay for the funeral if no other arrangements are made
  • Put it into a school or college savings account
  • Long-term means such as retirement or vacation

You can even use the death benefit to give money to charity. There are no restrictions on the use of payments from the deceased’s life insurance policy.

What is the cash value in terms of insurance?

Cash value in life insurance is the part of your policy that accrues benefits. Depending on the type of policy you have, you may be able to withdraw or borrow from this portion.

You may also hear a cash value referred to as a policyholder’s living benefit. many Policyholders will use the cash value as a savings accountwhile others may use this money to pay for emergencies.

It is important to note that the cash value does not go to the beneficiaries as it is separate from the death benefit. If any cash value remains after your death, that money remains with the insurance company.

Cash value builds up slowly, and this may be a reason why many people do not recommend a cash value life insurance policy.

However, many options are still available, with the cash value changing depending on the type of life insurance policy you purchase. For example, the cash value of whole life insurance will generally grow at a fixed rate set by the insurance company. On the other hand, term life insurance will not offer any cash value.

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Is the cash value of a life insurance policy subject to tax?

We previously discussed scenarios in which a death benefit can become taxable. There are also some situations in which the cash value of a life insurance policy may be taxed.

It is important to know when and why cash value becomes taxable to avoid unwanted surprises. The following are situations in which your cash value may become taxable:

  • If you waive your life insurance policy. Canceling coverage may make your cash value taxable. The taxable amount is the cash value in excess of the policy amount, called the policy basis. For example, if you waive the $20,000 life insurance policy, and the policy basis is only $10,000, the IRS will consider the other $10,000 taxable.
  • If you are selling your life insurance policy. If you sell your life insurance policy to a third party, you may have more money than if you gave it away, but it’s still taxable.
  • If you get a loan against your cash value. As mentioned above, cash value is not usually taxed, and taking out a loan will not be enough for taxes to apply if you repay the loan. If you fail to do so, you will have to pay the loan back and be responsible for the taxes due on it.

Making sure you know the cash value of life insurance is half the battle. Knowing how to avoid taxes is the second half, though if you don’t plan on messing around with your life insurance policy for as long as you have it, you’ll be in good shape.

bottom line

The good news is that death benefits and the cash value of a life insurance policy are not taxable. The better news is that unless you have extremely rare circumstances where you have a highly valuable property or need to give up your policy, you likely won’t have to pay taxes on the death benefit or cash value.

Always check your policy details to see how many people are involved in your policy, how much the death benefit is, and whether your life insurance tax liability is affected.

Frequently Asked Questions

Do you have to pay taxes on life insurance payments?

The life insurance policy payout, or death benefit, is not taxable because the IRS does not classify it as income. So unless the beneficiary signs up to receive annuity payments, the beneficiary will not be taxed.

Is a life insurance policy considered an inheritance?

A death benefit does not count as an inheritance if it is not absorbed by your estate. Therefore, if the death benefit goes directly to your beneficiaries, it will not go to anyone who belongs to your estate or is included in your will.

Does the beneficiary have to pay taxes on the payments?

Money received via life insurance payments is not taxable, meaning the money is free to use for bills or other needs.

Do you pay taxes on life insurance?

You do not pay taxes on a life insurance policy. Only in certain situations will the death benefit or cash value be taxed, but the coverage or the policy itself will not be taxed.

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Editorial Tips: We are a free online resource for anyone interested in learning more about life insurance. Our goal is to be an objective third party source for all things life insurance. We update our website regularly, and all content is reviewed by life insurance experts.

Rachel Brennan has been in the insurance industry since 2006 when she started working as a licensed insurance representative for 21st Century Insurance, during which time she held her property and casualty license in all 50 states. Several years later, she expanded her expertise in the insurance field, earning a license in health insurance and AD&D insurance as well. I worked for a small health in…

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Rachel Brennan
Licensed insurance agent
Rachel Brennan

Benjamin Carr was a licensed insurance agent in Georgia with two years of experience in life, health and property and casualty insurance. He has worked with State Farm and other risk management firms. He is also a strategy writer and editor with a background in branding, marketing, and quality assurance. He’s been in military newsrooms – literally on the front lines of journalism.

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It has been previously reviewed

Benji Carr

Previously Licensed Life Insurance Agent

Benji Carr

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