If you’re in the market for a life insurance policy, you may be wondering if the premiums are tax deductible. The answer to that question may depend on whether you’re purchasing an individual life insurance plan for yourself or procuring coverage for your employees. In this article, you'll learn how life insurance can impact the taxes of individuals and businesses and discover other potential tax benefits of life insurance policies.
Is Life Insurance Tax Deductible for an Individual Purchaser?
Life insurance isn’t currently tax deductible for an individual purchaser. Because neither federal nor state governments require people to buy and maintain life insurance, purchasing a policy is considered a personal expense. When you purchase a policy for yourself, your spouse or another family member, it’s essentially no different than buying clothing, cars or other personal items, so the premium isn’t tax deductible.
Is Life Insurance Tax Deductible If It’s Purchased for an Alimony Agreement?
If you’re required to purchase life insurance on behalf of an ex-spouse as a term of a divorce decree or alimony agreement that was effective prior to 2019, those policy premiums are likely tax deductible. This doesn't account for premiums of currently held life insurance policies that name your ex-spouse as a beneficiary, even if those terms are included in your divorce, separation or alimony agreements.
Due to tax code changes that went into effect on January 1, 2019, alimony and alimony-based life insurance premiums are no longer tax deductible.
Is Life Insurance Tax Deductible for a Business?
If your company purchases life insurance for its employees, policy premiums may be tax deductible if the following conditions are met:
- Policies are offered as an employee benefit
- The business is an LLC, sole proprietorship or S corporation
- The company or its owner cannot be the beneficiary or otherwise benefit monetarily from the policy
If these conditions are met, premiums for the first $50,000 of each employee’s life insurance coverage are considered tax deductible. Premiums for coverage in excess of $50,000 are still considered taxable income by the IRS.
Is Life Insurance Tax Deductible If You’re Self-Employed?
No. Although freelancers, independent contractors and other self-employed individuals may claim deductions for benefits such as health insurance coverage, life insurance is currently considered a personal expense and is not tax deductible.
Is Life Insurance Taxable to Beneficiaries?
When life insurance pays out, the proceeds are typically tax-free for the beneficiary. In most cases, a death benefit payout doesn't count as taxable income, so the recipient doesn’t have to pay taxes on the amount.
There are two notable exceptions in which the proceeds from a death benefit may be taxable:
- If the death benefit is paid out to an estate rather than to an individual, estate taxes may apply.
- If the death benefit is disbursed as annuity payments rather than as a lump sum, the interest that accrues may be taxable.
Do Life Insurance Policies Have Other Tax Benefits?
Although life insurance premiums aren’t typically tax deductible, your policy may have other tax benefits, including the ones listed here:
Tax Deferral on Cash Accumulation
Permanent life insurance policies with a cash accumulation component let you defer taxes while the cash value increases. This cash value can eventually be used as collateral to obtain a mortgage or other loan. Plus, if you surrender your policy, you won’t have to pay taxes on the cash value up to the overall amount you've paid on the premium. If the policy's cash value is higher than the total you've paid on premium payments at the time of surrender, the difference is considered a gain and is taxable as ordinary income.
If you’re receiving cash dividends from a life insurance policy, they’re typically tax-free. Essentially, as long as the dividends don’t exceed what you’ve paid on your premiums, they’re considered money back from an overpayment and don’t need to be reported as income.
When Should You Consult a Financial Professional?
When filing tax returns, it’s crucial to understand what the IRS requires you to report as taxable income. Unfortunately, tax laws change often and can be difficult to understand, making them challenging to navigate without the assistance of a knowledgeable professional. If you have questions about the taxability of life insurance or other policies, it may be helpful to consult a financial advisor, an estate planner or a tax specialist who can advise you on your specific situation.