Do beneficiaries pay taxes on life insurance policies?

If you’re considering or have recently purchased a term life insurance policy, you might wonder how a death benefit works. Do beneficiaries pay taxes on life insurance policies? How does the claims process work? Learning the finer details about life insurance policies can ultimately help you and your beneficiaries.

Nobody has time to sit and read through every detail relating to a life insurance policy. Therefore, this article serves to simplify how life insurance policies and taxes work for policyholders and beneficiaries.

Continue reading to learn whether or not beneficiaries pay taxes on life insurance policies, or enter your ZIP code above to obtain free quotes from the leading life insurance companies in your area. You could start saving today.

Is life insurance taxable?

Life insurance can be taxable in some situations but not many, according to the IRS. As a beneficiary, you won’t need to be too concerned about paying taxes on a death benefit from a term life insurance policy. If the insured has a whole or a universal life insurance policy, you might have to pay a bit more attention to tax compliancy.

The primary difference appears relative to the cash value component of the insured’s life insurance policy, if applicable. Term life insurance policies don’t build cash value and ultimately only offer a death benefit. The death benefit itself is not considered taxable income.

The cash value component of a permanent life insurance policy can build interest. That interest should be considered taxable income. Again, this only applies to certain types of life insurance policies.

Are life insurance proceeds taxable?

As mentioned above, most life insurance proceeds are not considered taxable income for beneficiaries. This is important to note because there are other forms of retirement solutions or estate planning tools that can be taxed. Even an inheritance is typically taxed.

One of the main advantages of a life insurance policy is that the death benefit is untaxable, in most cases. If you simply want your beneficiaries to receive as much money as possible when you die, a term life insurance policy can be your safest bet.

Typically speaking, permanent life insurance policies have a smaller death benefit than term life insurance policies. Permanent life insurance policies rely on the cash value component which can be partially taxed. The amount that you, as a beneficiary, are taxed is dependent on the amount of interest accrued.

Keep in mind that the accrued interest in a life insurance policy is also dependent on the type of policy. There are a few different permanent life insurance policy options, each with various features relating to the cash value. Depending on the amount and delivery of the accrued cash value, the proceeds could be taxed as follows:

• Estate tax
• Inheritance tax
• Income tax

If you inherit a large amount of cash from the insured’s policy, there is a possibility that a portion of that cash will be considered taxable.

Do you pay taxes on life insurance?

Clearly, the beneficiaries won’t be responsible for taxes on the main death benefit for a life insurance policy, but they could be for the cash value portion. You may be wondering if you have to pay taxes on life insurance as a policyholder. You won’t usually be required to pay taxes on a life insurance policy as a policyholder either.

That said, there are some unique circumstances in which a policyholder might be responsible for the taxes associated with a life insurance policy. The three most common situations in which a policyholder might have to pay taxes on their life insurance policy include:

• Withdrawing cash value
• Surrendering a policy
• Selling a policy

Yet again, permanent life insurance policies are more applicable when referring to life insurance tax concerns. A traditional term life insurance policy isn’t typically subject to any of the points above. If you really don’t want to pay for your term life insurance, you can simply cease doing so.

A permanent life insurance policy has built-in cash value, so you wouldn’t merely want to abandon that money. Unfortunately, surrendering a policy could involve a myriad of fees and other expenses, like taxes. Therefore, it’s best to keep your permanent life insurance policy, if possible.

Life Insurance Tax Benefits

Life insurance policies present an assortment of pros and cons. When you begin to consider how life insurance policies can help yield tax benefits, it makes them even more appealing. Overall, there are a few basic keys to understanding taxes and life insurance:

• Death benefits are provided tax-free
• Cash value contributions are tax-deferred
• Some cash value functions are tax-deferred
• Life insurance isn’t tax-deductible

Unfortunately, life insurance policies are considered more voluntary than some other forms of insurance. This is one of the anticipated reasons why life insurance policies don’t provide any tax deductions. You may recall that many health insurance policies can be tax-deductible during tax season.

Overall, most active life insurance policies have few tax concerns. But permanent life insurance policies may have some tax implications, especially if the policy is surrendered.

Taxes on Life Insurance Policies: The Bottom Line

Overall, life insurance policies can offer some nice tax advantages. Most of the time, beneficiaries won’t have to be concerned about filing taxes when receiving a death benefit. If you’re a beneficiary and have received cash value from a permanent life insurance policy, you may have to declare some proceeds as taxable income.

By now, you should have a better understanding of when beneficiaries pay taxes on life insurance policies. Before you go, enter your ZIP code below to obtain free quotes from the top life insurance companies in your area.