Understanding Taxes on Life Insurance

One of the greatest things about life insurance, other than that it provides for your loved ones in the event you should pass away unexpectedly, is that the proceeds that go to your beneficiaries generally are not taxable.

That said, there are situations in which part of the payout may go to Uncle Sam, and it is a good idea to be aware of them.

First, when the payout is made to a beneficiary after someone dies, it is not taxable. This is the most common use of life insurance, so you can rest easy knowing your insurance beneficiaries will not be hit with a tax bill.

A life insurance payout is also not taxed if it is made while the insured is terminally or chronically ill and there is a so-called terminal illness rider in place. In this case, the payout is generally treated as if it were paid upon the policyholder’s death.

So, when is a payout of life insurance taxable?

One instance is when payouts are made in installments instead of in full. Installment plans may help individuals who fear they will blow the lump sum all at once. If this is the case, and the payout is in installments, the death benefit is not taxable, but the interest that accrues on the payouts is.

Another situation that can make a life insurance payout taxable is having a large estate. In 2019, this applies to an estate that is worth more than $11.4 million. Why? In 2019, the Federal Estate Tax Exclusion amount is $11.4 million for individuals. If you have an estate valued above that amount when you die, any amount above $11.4 million is taxed at 40 percent. The part of your estate that your spouse inherits is exempt.

So, if your beneficiary is a parent, sibling, or child, the amount he or she receives is subject to the tax. This can happen when a spouse beneficiary passes away before the policyholder.

Are you concerned about taxes that may be due on a life insurance policy? Feel free to contact our office with any questions. We are happy to review your options and help you find the best solution based on your individual financial and insurance needs.