Do I have to pay taxes on Life Insurance?
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UPDATED: Nov 17, 2011
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Life insurance provides financial security to your spouse or children in the event of your death. The insured pays monthly premiums, and if the insured dies under circumstances covered by the policy, a death benefit is paid out to the named beneficiary on the policy. Death benefits can be used to pay funeral costs, pay off debts, cover lingering medical bills, or provide substitute income for the grieving family for a few months or years.
Life insurance benefits generally pay out much more quickly than inheritance, so the funds are available to the beneficiaries long before any other element of the estate may become available. Most of the time, life insurance benefits also are not taxed, so the beneficiary receives the whole amount of the benefit. In some situations, however, life insurance benefits are subject to taxes, or their pay-out will be delayed:
If the death needs to be further investigated by the insurance company to confirm that it can be covered, pay-out may take several months. For example, if the policy was lapsed at the time of death, or if the death is suspected to be a suicide or another non-covered cause, the insurance company will need to review the policy and the specific incident to see if coverage will apply. In these situations, benefits are still not subject to taxes, but may be received much later than normal, or not received at all due to a policy denial.
Possible Estate Taxes
If you do not name a specific beneficiary, your life insurance will be considered part of your estate. In that situation, your benefits pay to the general sum of your other assets, and are not available to your beneficiaries immediately but instead must be handled through inheritance. In this situation, pay-out will be delayed and your benefits may be subject to federal taxes as well. The best way to avoid this situation is by naming a specific beneficiary on your policy.
Loans from a Life Insurance
If you have a whole life or universal life insurance policy that you’ve borrowed money from, taken a loan out against, or paid up your policy in exchange for a different policy, then this could be considered an incident of ownership on your policy. This would qualify the benefits as taxable income to some dependents, although it may not occur until after your spouse dies also. This varies between different providers and is a possibility you should discuss with your specific insurance provider if you have that type of insurance.
In some cases, you can elect for your life insurance to pay out in several payments after your death. The remaining balance will remain in an interest-bearing account so that it can continue to accrue value even after pay-outs begin. This can be an excellent option for providing substitute income to your family. Before you make this choice, however, you should know that the interest-bearing portion of your death benefit is taxable income for your beneficiaries.
Life Insurance Premiums
Aside from the death benefit, you do pay taxes on your life insurance premiums. Life insurance is not counted as a medical expense by the IRS, meaning that it’s not tax deductible unlike other types of insurance. You must pay your premiums with after-tax dollars, and cannot recover those funds, so in that sense you do certainly pay taxes on life insurance. If your employer provides your life insurance, however, they are able to deduct the policy on their own business taxes as a business deduction.
If you have any questions about the way your life insurance works, or are uncertain about the details of your death benefit, the best thing you can do is contact your life insurance provider. By discussing your benefits pay-out with your insurance company, you can be sure to understand exactly what you’re paying for. With life insurance and other types of financial programs, understanding what you’re paying for is imperative to getting the best deal. You may be paying for something without realizing exactly how it works, and by the time you’ve passed away it is too late to solve any problems with the policy.
If you don’t have life insurance but are looking to purchase a new policy, take care to review the details of any potential policy that you get a life insurance quote from. By discussing the details with the company’s representative before you purchase the policy, you can be sure to buy coverage that provides the protection you need within any constraints you have. Research can guarantee that your policy is the best possible match for your family’s needs and your budgetary concerns.
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