November 27, 2021
  • November 27, 2021

Here’s when the product is taxable

By on September 15, 2021 0

Generally, beneficiaries of a life insurance policy will not have to pay income tax when they receive a death benefit, but there are some exceptions to this rule. Understanding the full tax implications of a life insurance policy can help beneficiaries make the best decisions about how to handle the proceeds received from a life insurance policy.



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Most people choose life insurance to protect their loved ones and leave them in a better financial situation. But will the beneficiaries of the policy be obliged to pay taxes?

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Are life insurance products taxable?

You may be wondering “is life insurance taxable?” The IRS says the proceeds from a life insurance policy are generally not considered gross income for the beneficiary. However, there are exceptions. For example, interest received by a beneficiary following the death of the insured should be reported as income. A recipient may also have to report part of the payment as taxable income if they receive it in exchange for cash or something of value, up to the full amount of what was spent.

There are a few exceptions when you may need to pay taxes:

When payment is made in installments instead of a lump sum

The benefit can be paid in two ways: all at once or in installments. Some people prefer to receive money over time to avoid spending the full amount. But they should know that the interest is taxable.

Jonathan Holloway, co-founder of NoExam.com, a digital life insurance brokerage firm, explains, “If the payment is paid in installments, the interest accrued on the payments is taxable. The death benefit is not taxable, only the interest on the installments. “

If the beneficiary is an estate

If the policyholder names an estate as the beneficiary of a life insurance policy, the process becomes complicated. If the death benefit increases the value of the estate above $ 11,700,000, your beneficiaries will need to complete an IRS Form 706, also called a “US Estate (and Generation Transfer) Tax Return.” “. Leaving the proceeds in an estate adds to its value, which could result in higher estate taxes for your heirs.

Proceeds left to a beneficiary may be taxable under the deceased’s estate, both at the federal level and at the state level in some cases. An inheritance tax may also be due in cases where the beneficiary is not the estate.

When you exit a cash value policy

This may not be a taxable matter, but still affects the beneficiary. The policy owner can borrow money from a cash value policy. If you borrow against your policy and don’t pay it back, the insurance company will deduct what you owe before paying the death benefit.

A cash value policy where premiums paid are greater than the amount allowed in order to maintain full tax treatment is called an amended endowment contract (MEC). With a CEM, cash value distributions are first deducted from taxable earnings, as opposed to distributions which are taken from non-taxable contributions. In other words, when a life insurance policy is considered a CEM, tax-free withdrawals are not available from the cash value of the policy.

Cash value policies can impact beneficiaries in other ways, including the following scenarios:

  • Exchange of the cash value for an increase in the death benefit – Typically, upon death, the cash value of a whole life insurance policy reverts to the life insurance company. Most companies will honor an insured’s request to convert a portion of the cash value into a death benefit.
  • Life insurance premiums paid from the cash value – An advantage for the insured is that once the cash value has accumulated to a certain point, it can pay for the outstanding premiums. This can reduce the monthly expenses of the insured, but will also reduce the payment of life insurance for the beneficiary.
  • Cash surrender value loans – An insured can borrow against the cash value of a policy. Upon death, any outstanding loan balance will reduce the beneficiary’s life insurance amount accordingly.

What to do with the life insurance product?

There is no set rule of what to do with your life insurance proceeds. It can be tempting to go on a spending spree when you first receive the money, but postponing spending for a while and seeing a financial advisor can be a smart move.

Thomas D. Currey, owner of TDC Financial Services in Grand Prairie, Texas, and chairman of the board of the nonprofit Life Happens, is warning individuals to watch out for their new windfall. “The only word of warning I would have is that when someone goes into a big amount of money, it’s easy to spend first and ask questions later,” said Currey. “Seeking advice to help you assess your current needs and how to meet them as far as possible is always a good idea. “

You already know the scenarios that answer the question “is life insurance taxable?” As for what to do with the death benefit, here are a few ideas:

Pay off high interest debt

If you have credit card debt or are paying off student or personal loans with high interest rates, paying off the debt can save you money on the interest you pay. It helps to be systematic in this process. Prioritize debts based on the highest interest rates and pay them off first.

Set aside money for your children’s education

Create a college fund for your children by putting money into a 529 Education Savings Plan. The funds can be withdrawn tax-free to pay for eligible school expenses. If possible, when paying for your education, use the available tax credits first. After that, consider using 529 funds from the remaining expenses, while paying attention to penalties. You must withdraw 529 funds during the year, they will be used for school expenses.

Create an emergency fund

If you’re living paycheck to paycheck, an emergency fund might take some of the pressure off. You should have between three and six months of living expenses in your emergency fund to cover your cost of living if you lose your job, your car breaks down, or if you become ill and unable to work. In creating a sufficient emergency fund, use the adage “pay yourself first”. You could agree to put a fixed amount into the fund each month before more bills are paid.

Frequently Asked Questions

Is life insurance taxable if you cash it in?

In most cases, your beneficiary will not have to pay taxes on the death benefit. But if you want to cash out your policy, it may be taxable. If you have a cash value policy, withdrawing more than your base (money earned) is taxable as ordinary income. It’s best to check with your provider before cashing out – some policies state that cash withdrawals made in the first 15 years are taxable.

Do you get a 1099 for the life insurance product?

You will not receive 1099 for the life insurance proceeds because the IRS generally does not consider the death benefit as income.

Are life insurance premiums tax deductible?

Premiums are not deductible unless they are paid to someone else, for example, as part of a support agreement.

Can Employee Life Insurance Premiums Be Tax Deductible?

Although insurance premiums are generally not tax deductible, some portions of the employee life insurance premiums paid by a business may be tax deductible. In addition, funds equal to the premiums paid may be tax exempt when a policy is surrendered.

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