Is Life Insurance Taxable?
If you have loved ones who depend on you financially, you need life insurance. why? The answer is simple.
A life insurance policy payout can help your loved one keep paying the bills and help pay for funeral expenses when you’re not there to support them. Sean Mulaney, Certified Public Accountant and Company President, says: Maulani Finance and Taxes.
But the question becomes: Is fixed-term life insurance taxable? Because life insurance benefits can be a lifeline for families, federal tax law and state law are designed to protect insurance payments, Mulaney says. That’s right – although nothing is certain except for death and taxes, death benefits usually get away with tax.
However, there are a few instances in which life insurance death benefits can be subject to taxation. It is important to be aware of these situations to limit the tax liability for life insurance payments.
Why are life insurance proceeds usually not taxable?
There are two basic types of life insurance, term insurance and permanent life insurance.
So what is term life insurance and how does it work? With a fixed term life insurance policy, coverage lasts for a set number of years and is usually one of the most affordable types of life insurance. For example, a 30-year-old woman can purchase a 20-year Haven policy, issued by MassMutual or its subsidiary, CM Life, with $250,000 life insurance benefits starting at $10.87 per month. If you die within the term of your policy, your beneficiaries can file a claim with the insurance company to collect death compensation.
A permanent life insurance policy provides coverage that lasts for life, as long as the life insurance premium is paid.
Payments from either of these two types of life insurance are generally not taxable to beneficiaries and are not considered taxable income.
“If you look at congressional committee reports from the early 1900s regarding this provision of the income tax law, you will see that there is a strong concern about ‘widows and orphans,’” says Logan Alec, a chartered accountant and owner of the personal finance site The money was done correctly. “So this exemption from life insurance returns is really rooted in social concerns, and that income tax exemption has persisted to this day.”
How options for payment of death benefits can affect my tax liability
While the beneficiary generally does not pay tax on payments, there are a few instances in which they may do so. Life insurance companies usually offer a few different options for receiving death benefits from an insurance policy. The default option is to pay a lump sum, which is generally tax deductible.
However, if you or your beneficiaries choose to receive payments in installments over time, a portion of those payments may be subject to tax.
“If you receive life insurance proceeds in separate payments over time, and the sum of those premiums is greater than the amount you would have received from the insurance company if you had taken a lump sum upon the death of the insured, then those payments to you count as interest,” Alec says. Interest can be taxed on the lump sum as per the ordinary income tax rate.
As the policy owner, you must receive a Form 1099-INT from the insurance company to report the taxable interest, Mulaney says. You may also be subject to additional tax on this interest if you are a high-income earner.
Single taxpayers with a combined adjusted adjusted gross income (MAGI) of $200,000 or more, and married taxpayers who jointly file with a MAGI of $250,000 or more must pay 3.8% net investment income tax – Also known as the Medicare Supplemental Tax – on investment income such as interest.
Real estate taxes and life insurance payments
Mulaney says people with a large life insurance death benefit have been worried about the estate tax. This is because the maximum amount of assets – including life insurance coverage – that could be passed on to tax-exempt heirs was much lower than it is now.
For example, in 2004 a tax return had to be filed for properties over $1.5 million, according to tax authority. For 2020, the federal tax credit covers real estate valued at up to $11.58 million. “If you have a lifetime term policy and it’s included in your property, you probably don’t have to worry about estate tax,” Mulaney says.
If you have a large property, though, Allec suggests working with a tax planning financial expert to discuss tax minimization strategies.
To keep your insurance payments out of your estate, “it may be a good idea to transfer ownership of your policy to someone else, possibly a life insurance beneficiary,” says Allec. Another strategy is to transfer ownership of your life insurance policy to an irrevocable insurance trust, where the proceeds of the life insurance policy can be isolated from property taxes, subject to certain requirements. Again, work with a tax planning professional to see what might suit your specific situation.
Expedited Death Benefits and Taxes
Your life insurance company may offer a rapid death benefit rider – a rider that can be added to your policy that will allow you to collect a portion of your death benefit while you are alive to pay for medical care if you are terminally ill. There can be an additional fee for this passenger, but with the Haven Term policy, it is included in the policy, and an administration fee is charged if the passenger exercises.
In general, you can receive tax-deductible express death benefits if you are approved by a physician as a terminally ill and are expected to die within 12-24 months (depending on policy terms). If you have a chronic, but not incurable, illness, you can still qualify for the tax credit if you use payments for qualifying long-term care expenses, Mulaney says. Ask your tax planner about exceptions that may exist.
Cash value payments and taxes
In addition to offering death benefits, permanent life insurance policies build cash value over time that can be leveraged through withdrawals or loans while you are alive. In most cases, withdrawals up to the total of the premiums you paid are not taxed, and loans of any amount (assuming you pay them back) are not.
However, taking withdrawals or borrowing for the cash value increases the chances of the policy forfeiting, reduces the cash value and death benefits, and may result in a tax bill if the policy expires before the insured’s death.
Life insurance tax and settlement
Another way to get life insurance benefits before you die to pay for your care is through what’s called a life insurance settlement, otherwise known as a statutory settlement. There are companies that buy life insurance policies from terminally ill people for more than the cashback value but less than the face value.
Mulaney says the money you will get from a court settlement will be tax deductible if you are certified by a doctor as terminally ill and are expected to die within the next 24 months. However, the third party that purchases your policy will have to pay taxes on the payments they collect from the policy upon your death.
Group life insurance and taxes
You may receive some type of work life insurance coverage. If you have employer-provided life insurance, known as group life insurance, any coverage over $50,000 is treated as taxable income, but any amount less than $50,000 is not taxable.
Group life insurance can be a great addition to your benefits package, especially if it’s free or semi-free. But these policies can sometimes be insufficient if you have a growing family or life insurance needs change throughout your career.
Use our online life insurance calculator to help you figure out your coverage needs.
Peace of mind and taxes
Every tax situation is different. If you are concerned about being taxed on life insurance payments, you should consult a tax professional.
If you are a Haven Life customer and have questions about whether your policy payments are taxable, the Customer Success Team is available to help answer your questions.
If you don’t have life insurance, consider the peace of mind that comes with financial protection for your loved ones in a way that, in most cases, is tax-deductible. Get your life insurance policy rate.
About Cameron Huddleston
Cameron Huddleston is the author of the book Mom and Dad, We Need to Talk: How to Have Basic Conversations with Your Parents About Their Finances. She is an award-winning journalist with over 18 years of experience writing on personal finance. Her work has appeared in Personal Finance, Business Insider, Chicago Tribune, Forbes, MSN, Yahoo and many other print and electronic publications. US News & World Report named Cameron as one of the top personal finance experts to follow on Twitter, and AOL Daily Finance named me one of the top 20 personal finance influencers to follow on Twitter. She has appeared on CNBC, MSNBC, CNN, and “Fox & Friends” and has been a guest on ABC News Radio, Wall Street Journal Radio, NPR, and over 30 podcasts. Cameron was also interviewed and cited as an expert on New York timesand Chicago Tribune, BBC.com, MarketWatch and more.
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