Is life insurance tax-free?
When it comes to buying life insurance, understanding the process is key to ensuring your own peace of mind. Life insurance is about protecting your family’s financial future – and you want to make sure the money you leave behind goes to them, not to Uncle Sam.
The good news? In most cases, life insurance benefits are completely tax-free. It’s important to understand if and when your family will need to pay taxes, so they’re not hit with a surprise bill during an already tough time.
By empowering yourself with the facts, you can make the most informed decisions and choose the right policy to protect your family. Here’s a closer look at some of the most common questions about life insurance and taxes.
Is life insurance tax-free?
Most of the time, your loved ones won’t have to pay tax on your life insurance payout. Here’s how it all works:
- When you purchase life insurance, you choose a coverage amount. You can typically choose from term life insurance, which can last anywhere from 10 to 30 years, or permanent insurance, which lasts your entire lifetime.
- During the life of the policy, you might make monthly or yearly payments called premiums on your policy.
- If you die when the policy is active, your family will receive the full amount of your death benefit – no strings attached.
While you won’t have to deal with taxes on life insurance most of the time, there are a few scenarios where your life insurance payout may not be tax-free:
- If your insurance company pays your life insurance benefit over a longer period of time and the payout accrues interest, that interest could be taxable. The percentage of interest and time period varies from state to state. Your insurance company should explain your payout options for your policy.
- With some permanent policies that build cash value over time, you can only put a certain amount of cash into the policy – anything additional could cause the policy to not be considered a tax-free life insurance policy.
- If the policy owner, the insured, and the beneficiary are three separate people, the IRS may view that payout as a gift instead, which could make some or all of the payout subject to taxes. For example, if you purchased a policy that insured a family friend and your child was the policy beneficiary, the IRS may tax the payout as a gift. Keep in mind that the gift tax doesn’t always apply in this situation. Ultimately, the IRS makes the final determination.
The bottom line: Being taxed on a life insurance payout is not that common, and thankfully something the vast majority of Americans don’t typically need to worry about. That’s one more reason life insurance is a cost-effective way to ensure your family is covered financially, no matter what happens to you.
Are life insurance premiums tax-deductible?
Wondering if you can write off those premiums on next year’s taxes? Typically, premiums are considered a personal expense, which means your life insurance premium is not tax-deductible. Potential exception may exist when you’re buying a policy for business reasons (for example, if you’re a partner in a business and need to be covered based on your agreement). Fortunately, typical life insurance premium amounts are relatively small in relation to the death benefit, so not taking tax deductions on your premiums may not make much difference in the end.
What about taxes on group life insurance?
Group insurance includes any policy where you apply and receive coverage as part of a group. These can include employer-provided group insurance plans or policies from member associations, such as term life, disability insurance, and other types of coverage. In some cases, the group may cover some or all of the cost of your insurance.
While individual policies typically aren’t taxed, there are some exceptions with group life insurance. If your employer provided policy is more than $50,000, any amount beyond $50,000 gets taxed on your paycheck. Any amount below $50,000 is not taxed. Your policy or employer can provide specifics on how your policy will work.
Group life insurance can be an affordable way to get covered, especially if your employer helps to foot the bill. It’s important to note that group life coverage amounts tend to be lower than individual policies, though, and in most cases you can’t take it with you if you leave your job. It’s smart to consider supplementing your employer provided policy with your own individual life insurance policy.
Planning for life insurance and taxes
Overall, life insurance is a great way to help ensure that your family is protected – and it’s tax-free most of the time. It’s important to talk to a life insurance agent or tax advisor about the impact of taxes on your policy, especially if you’re considering permanent life insurance. Effectively planning for your life insurance purchase – and being aware of any potential taxes – can help you feel confident your family will be covered when it counts.
Have more questions about life insurance and taxes? We’re here to help. Shop your life insurance options with eFinancial or call one of our dedicated agents at 800.957.9525.
At eFinancial, our goal is to make life insurance simple, affordable, and understandable for everyday families. This content is intended for educational purposes only. Each post is carefully fact-checked, reviewed and updated regularly to ensure the information is as relevant as possible.