Life Insurance

How Is Life Insurance Taxed?

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We buy life insurance to protect our loved ones, so the last thing we want to do is leave them holding a big tax bill on the benefit they receive. Fortunately, one of the greatest benefits of life insurance is that the proceeds are typically not taxable.

Taxation of Life Insurance

The IRS states, “Life insurance proceeds you receive as a beneficiary due to the death of the insured person, aren't included in gross income, and you don't have to report them. However, any interest you receive is taxable, and you should report it as interest received.“

However, there are a few other scenarios that could result in a life insurance tax bill: 

  • You elect to receive delayed payouts. Most death benefits are dispersed in a lump sum payment. If you elect to be paid in installments, the proceeds are held in an interest-bearing account, and you’ll pay taxes on any interest that accumulates. 
  • You make a withdrawal against the cash value of the policy. Some whole life policies build up cash value over time. You won’t pay taxes on the cash value as it grows. But any withdrawals that exceed what you’ve paid in premiums are subject to taxation.
  • You take out a loan against the cash value of the policy. Loans against the cash value of a life insurance policy are permissible, and you won’t be assessed federal income tax. But suppose you surrender the policy or it's terminated for nonpayment. In that case, you will pay taxes on the amount you withdraw that is greater than the premiums you’ve paid towards the policy (or your policy basis). 

Also, be mindful that any outstanding loan balances at the time of your death will generally be deducted from the death benefit that’s dispersed to your beneficiaries.

  • You terminate coverage and surrender the policy. You’ll get a payout for the cash value, minus the surrender charge, if applicable, when you end your coverage. Note that policies sold by Ethos do not have a surrender charge.

    The payout amount that’s greater than your policy basis is taxable. To illustrate this, assume the surrender value of your policy is $15,000, and the life insurance provider assesses a surrender charge of $1,500. If you receive $17,000, you’ll be taxed on $3,500.

  • Your policy names your estate as the beneficiary. If your estate is valued at $11.7 million or more, it is ineligible for an exemption from federal income tax. Consequently, federal and state estate taxes could reduce the death benefit.

You sell your policy in exchange for cash. If you sell your policy for cash through a life settlement, you could be taxed on the funds you receive. However, viatical settlements, which allow terminally ill individuals to sell their policies to cover medical expenses, are exempt from federal taxation.

Wonder how much coverage you need?
Our coverage calculator helps estimate how much coverage you need to protect your family.

There are additional exceptions and special cases when life insurance is purchased by a business. Still, most life insurance plans purchased by individuals will not require their beneficiaries to pay a tax bill on the proceeds. 

The counter side is that your life insurance premium is typically not tax-deductible, as the IRS considers it a personal expense. But if you’re a business owner that pays premiums for a life insurance policy that covers an officer or employee, you could deduct the costs as a trade or business expense.

Compare Plans

If you don’t yet have a policy and are ready to take the first step towards securing your family’s financial future, get a free online life insurance quote from Ethos today. 

There are two coverage options to choose from:

  • Term life insurance: This caters to individuals between 20 and 65 and provides coverage for up to $2 million. This form of coverage is highly recommended and comes with 10, 15, 20 or 30-year terms. If you outlive the policy, you’ll need to renew it or purchase a new one.
  • Whole life insurance: These policies are reserved for applicants between 66 and 85 and offer coverage of up to $30,000. Whole life insurance covers you until you pass away, assuming you make timely premium payments. But you’ll no longer have to pay for coverage once you reach 100 years of age. 

Aren’t quite sure how much coverage you need? Ethos also provides a handy calculator that does the work for you. 

There’s no need to talk to an agent, no blood tests or medical exams - just answer a few online health questions. It’s really that easy, and most get same-day coverage at a truly affordable price.

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