When Is Life Insurance Taxable?
In most cases, a life insurance death benefit isn't subject to taxes, according to the IRS. That's because a life insurance payout isn't considered "gross income" and therefore doesn't need to be reported on your income tax returns. However, there are a few exceptions — including if you receive interest on a payout.
The Good News for Life Insurance Beneficiaries
Generally speaking, if your beneficiaries receive a payout, they won't owe taxes — whether it's a permanent or term policy. If you have a permanent policy, the same applies to gains in cash value of the policy or if you decide to surrender the policy for a lump sum.
However, according to NerdWallet, there are a few specific situations where you could owe taxes. They can include (among others):
- Interest – Some plans may payout a death benefit in installments with interest. You would be required to pay taxes on the interest.
- Profit on cash value – If you surrender a policy with cash value and end up making money on it, you'd owe taxes on the amount of profit.
- Your policy is part of your estate – If your estate is large enough to be taxed, then your life insurance proceeds could be taxed, too.
When Life Insurance Is Subject to Estate Taxes
Life insurance proceeds may be subject to estate taxes. According to Forbes, if you establish "incidents of ownership" — such as borrowing against your policy, among other actions — the policy may be included in your estate and taxed. Because taxation issues are enormously complicated, always consult with a tax professional or financial adviser to ensure you are taking the best course of action.
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