Losing a loved one is extremely difficult. Not only are you emotionally drained, but now you have to consider next steps pertaining to finances. Your family may struggle to pay for funeral expenses and new costs as they adjust to changes in their life. The right policy can greatly help your family by relieving some of that financial burden, but surprise taxes on your beneficiaries’ life insurance benefits could cause serious problems.
Call us at (866) 786-0725 every weekday from 9 a.m. to 5 p.m. and one of our agents will help you find a life insurance policy that won’t lead to unnecessary headaches for your beneficiaries. Get started now with our free online quoting tool and find the best life insurance policy for you and your loved ones.
Is a Life Insurance Payout Taxable?
Typically, life insurance is not taxed, but there are specific cases where it could be. Whether or not a tax is imposed on a life insurance payout depends on how beneficiaries are classified and the payout structure. Final Expense Benefits is here to explain various situations where a life insurance payout can be taxed.
Are Life Insurance Annuity Payouts To Beneficiaries Taxable?
Life insurance policies are often paid out in full as a one-time payment. However, a policy may also be structured as an annuity, which means it is paid over a period of time in several smaller sums. These types of accounts benefit from gaining value over the life of the accounts, but life insurance annuity payouts to beneficiaries may be taxable if they accrue interest.
Are Loans Taken On Life Insurance Policies Taxable?
Some life insurance policies can accrue interest or gain cash value over time. Similar to a mortgage, the policyholder can take out cash as a loan against the policy’s value. The excess could be taxed if the withdrawn money exceeds the total value of paid premiums.
Tax On Life Insurance Surrender
If the policyholder no longer needs or wants their life insurance policy, they are able to surrender their contract. Usually, the policyholder will receive the money back that had been paid into the policy. However, any earnings exceeding the policy’s cash basis (the amount paid into the policy through premiums and other fees) will be taxed as standard income.
Life Insurance Estate Taxes
The IRS also states that if the life insurance payout is included as part of the deceased’s estate, taxes may be owed if it exceeds a certain threshold. Below is a portion of the IRS table stating the changes in those thresholds over the last several years. Estates with a total value exceeding these amounts will be subject to an estate tax, and if they include a life insurance payout, that may also be included in that tax.
| Year of Death | Estate Filing Threshold |
|---|---|
|
2022 |
$12,060,000 |
|
2023 |
$12,920,000 |
|
2024 |
$13,610,000 |
|
2025 |
$13,990,000 |
Imputed Life Insurance Tax on Employer-Sponsored Group Plans
Employer-paid group programs are a great way to get extra benefits. However, life insurance proceeds on group plans like this may be taxed.
Life insurance payouts that are employer-paid are only taxable if their value exceeds $50,000 and if the policy is considered “carried” by the employer. The IRS states that a life insurance policy is carried by the employer if it pays any cost of the policy, or the employer arranges for premiums paid by employees to help subsidize the premium cost for other employees.
According to the IRS, any payment over $50,000 from an employer-paid program may be taxable.
How to Report Life Insurance Payouts on Taxes
Generally, a beneficiary receiving a life insurance payout doesn’t need to report the proceeds as income.
However, some policies, such as certain universal life insurance plans or annuities, may pay interest based on the cash value of the policy. Any interest received is taxable interest and should be reported on IRS interest documents.
There are also some tax consequences for changing ownership of a life insurance policy’s death benefit. If the policy was transferred to the beneficiary for cash or other valuable considerations or as a gift, it may be subject to taxes. Typically, policy transfers would be reported as standard income or on a tax interest or distribution document. Per the IRS, general life insurance tax exclusions are limited to the value paid for the transfer.
Conclusion
So is life insurance taxable? Usually no, but some factors could lead to your beneficiaries owing on your policy. We understand that life insurance can be stressful and confusing, so if you have any questions or want to make sure your policy won’t incur unnecessary taxation, contact our expert agents here at Final Expense Benefits.
Contact us at (866) 786-0725 every weekday from 9 a.m. to 5 p.m. or check our free online quoting tool and we can help you steer clear of issues that can lead to your loved ones owing taxes on your life insurance plan.
Frequently Asked Questions
Is Life Insurance Taxable to the Beneficiary?
Typically, no. However, there are certain cases where your policy may be taxed. If you are curious about whether your beneficiary may be taxed on your held policy, check out this IRS tool to help determine the taxability of a life insurance payout.
Do You Have to Pay Capital Gains Tax on a Life Insurance Payout?
No, a standard lump-sum life insurance death benefit payout is not classified as a sale or exchange.
Are Taxes Owed if Beneficiaries Receive Multiple Life Insurance Policy Payouts?
Having more than one policy will not inherently cause you to owe taxes, but taxes may be owed if any policies fall under the listed exception cases.
Would the Policy Type (Whole Life, Term Life, or Universal Life Insurance) Cause a Life Insurance Policy to be Taxable?
Whole life and term life policies will often have no differences on tax implications and will likely not be considered taxable income or capital gains. However, universal life insurance often pays interest based on the policy’s cash value. Any earned interest must be reported on taxes.
What Are the Tax Differences Between a Life Insurance Death Payout and an Inheritance?
Beneficiaries generally are not required to pay taxes on life insurance payouts, but inheritances are often taxed. Having a life insurance policy also avoids the transfer process, which can lead to complications in inheritance distributions.