The Ins and Outs of Life Insurance Taxation

Life insurance proceeds received by your beneficiaries generally are not taxable, but there are situations in which part of the payouts may go to Uncle Sam, and it is a good idea to be aware of them.

First, when the payout is 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 beneficiaries will not be hit with a tax bill.

Second, when there is a “terminal illness rider” in place and the payout is made while the insured is terminally or chronically ill, the payout is generally treated as if it were paid upon the policyholder’s death, so it is not taxable.

So when is a life insurance payout taxable?

One time is when payouts are made in installments instead of in full. Installment plans may help individuals who are at risk of spending the lump sum all at once (new sports car, anyone?). If the life insurance payout is made in installments, the death benefit is not taxable, but the interest that accrues on the payouts is.

Another time a life insurance payout is taxable is if your estate is large. In 2022, that means it is worth more than $12.06 million. If you have an estate valued above that amount when you die, any amount above $12.06 million is taxed at 40%. Only spouses are exempt, so if your beneficiary is a parent, sibling or child, he or she is subject to the tax. This can sometimes happen when a spouse beneficiary passes away before the policyholder.

If you’re concerned about the taxation of your life insurance policy or think you need a policy, you should talk to us. Call or email us for more information.