If you are planning your future financial goals, you must consider life insurance. Life insurance gives you a peaceful life and helps you live worry-free. With life insurance coverage, you can offer a helping hand after your death to your family. But is life insurance taxable? Let’s find out the answers!
Many people have the same question when it comes to filing their income tax returns: Is life insurance taxable? What taxes do one have to pay for a life insurance policy?
Is Life Insurance Taxable
Once their policies mature, life insurers pay thousands of dollars to their family members. Life insurance payouts are generally not taxable as income to the beneficiaries. However, this does not mean premiums are paid, including taxes; rather, the death benefit received by beneficiaries is typically tax-free unless certain conditions apply that could render parts of the benefit taxable.
However, the beneficiaries must pay taxes on the maturity amount under certain conditions. We will walk you through the conditions under which the life insurance coverage is taxable.
Condition 1: Interest Payouts
A life insurance policy gives a lump sum amount upon the death of the policyholder. If the beneficiary of the policyholder delays getting the maturity amount, the amount starts earning interest.
On the other hand, if the policyholder chooses to get the maturity amount in installments, the remaining amount of the policy starts earning interest.
Interest earned on a delayed payout or held in installment accounts may be subject to income tax. However, the original death benefit is not taxed, regardless of when it is collected. If it starts earning interest, the interest you earn attracts taxes.
Condition 2: No Beneficiary
Life insurance policies are made tax-free, which means the beneficiaries get life insurance coverage with zero taxes. However, if the policyholder doesn’t include the name of the beneficiary or if the beneficiary already dies, in this case, the maturity amount goes into the policyholder’s estate.
Suppose the policy’s proceeds go directly to the estate due to a lack of beneficiary designation. In that case, the death benefit can become part of the taxable estate for estate tax purposes, not income tax. It attracts both types of taxes, federal and state taxes.
In other scenarios, if the policyholder’s estate value is under the taxable amount, but the maturity amount adds to it, making it above the taxable amount. In this case, it attracts even higher taxes as the total maturity amount and the amount of estate combine to attract taxes.
To keep things simple, one must include the beneficiary’s name and contingent, who acts as a secondary beneficiary who earns the maturity benefits if both the policyholder and the beneficiary pass away.
Condition 3: Upon Surrendering the Policy
In some cases, the policyholder has to surrender his policy because he doesn’t want the maturity benefits of the policy. In this case, your policy will be terminated, and the policyholder will get the policy’s surrender value. The surrender value is calculated per the policy’s terms and conditions. You will be guided on this term when acquiring the policy.
Generally, the policy value is your total cash minus the charges of your surrender procedure. There will be no surrender charges if you have completed 20 to 30 years of the policy. Upon surrendering it, you can get your policy’s total cash value, and there will be no hidden charges.
The difference is taxable as income if the surrender value exceeds the premiums paid. Therefore, you may be taxed on the portion of the surrender value that exceeds the premiums you’ve paid into the policy. Any gain realized upon surrendering the policy—meaning the surrender value minus the premiums paid—is considered taxable income.
If you have paid $50,000 as premiums on the policy and get $55,000 in return after surrendering the policy, the difference amount of $5,000 will attract taxes.
Condition 4: You Sell the Policy
If you have a life insurance policy with cash value benefits, you can sell your policy to investors. There is a market for ill policyholders with fewer life expectancies.
Some companies are interested in buying such policies. They pay money against your policy, become the owner of the policy, and pay your premiums on your behalf. They claim the maturity amount when you pass away!
Selling a life insurance policy, known as a life settlement, may provide the policyholder with a lump sum. However, the proceeds from selling a policy are typically less than the death benefit but more than the cash surrender value and may be taxable. In return, the companies help patients pay their expenses.
Condition 5: You Took Out Loans on Policy
A life insurance policy with cash value allows policyholders to get a loan against their policies. Since the policy is active or in force, the loan you get against the policy will not be taxable. If a policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the premiums paid into the policy is taxable as income.
The taxed loan amount exceeds the total premiums you have paid. If you have paid $50,000 in premiums and get a loan of $55,000, then $5,000 is the taxable amount.
Withdrawals up to the policy basis (the total amount of premiums paid) are not taxable, but amounts exceeding the basis are taxable as income.
What if you die before the loan ends? The remaining loan amount will be reduced from the maturity benefits against your policy in this case.
The table below explains when your life insurance policy attracts taxes and when it does not!
Conditions | Taxable portion |
---|---|
Upon surrendering the policy with cash | The taxable amount is the money that exceeds the policy basis amount. |
Upon withdrawing money from the cash value | The taxable amount is the money that exceeds the policy basis amount. |
Upon taking a loan against the policy | There are no taxes as your policy is in force. |
Upon the policy going into the estate | If the amount of estate is above the taxable amount. |
Upon selling your policy to a company | There are no taxes on it. |
Upon delaying in receiving the policy maturity amount | The interest you receive attracts taxes. |
The Final Word:
A life insurance policy is crucial if you are worried about your family after death. It has many benefits and gives you relief as your family will have enough money to survive. Since life insurance companies offer different policies, you must compare the plans and choose the one that suits your needs.
Before selecting your premiums, you must calculate your total annual income, expenses, and other money needed to perform your day-to-day tasks. This blog has explained everything in brief.
You must obtain all the information about the policy, its cash value, surrender value, loan percentage, and other terms described in this guide. This guide will help you share this information with your family so that they can claim the selected benefits upon your death.
See Also
No Medical Exam Life Insurance for Seniors
Is Long Term Disability Taxable
Is Medical Insurance Tax Deductible
Are Medical Expenses Tax Deductible
Are Medical Bills Tax Deductible
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