Life Insurance and Taxes

Posted on April 1, 2015 by

Life Insurance and Taxes

Is life insurance taxable?

Are insurance proceeds taxable?

Is life insurance taxable income?

The above questions are asked by first time and seasoned life insurance clients. It really isn’t surprising that they would wonder about their life insurance proceeds taxable amount.

So, are life insurance benefits taxable?

In short, there is sometimes tax on life insurance and there may be taxes on life insurance. There are some life insurance proceeds taxable by the IRS. Tax on life insurance proceeds, life insurance tax benefits, and life insurance taxable income do have some implication concerning the amount of income tax on life insurance.

Beneficiary Taxes

If your beneficiaries receive the proceeds of a life insurance policy, the benefits will not be included as part of their gross income on their tax reporting. Interest that has been received on that policy would need to be reported in the interest area of your tax report. The sooner you pay off your life insurance loan, the less interest you’ll have to pay.

When someone has a hybrid annuity or life insurance policy with a long term care insurance rider, where long term care benefits are left over, the heirs will get a tax free death benefit. Claims paid from these policies are tax free if the long term care expenses are qualified.

Irrevocable Life Insurance Trust (ILIT)

Life insurance tax is not a reality, but the amount of the proceeds of your policy may increase the amount of taxes payable by your estate unless you form an irrevocable life insurance trust (ILIT).

The ILIT owns your life insurance policy, thereby removing it from your estate.  You would not be able to put the policy back in your own name.  Since it is not “in” your estate, your estate taxes would be lower.

Whole life | Universal Life

Whole life and universal life policies both have deferred tax responsibilities.

Modified Endowment

In the case of a modified endowment contract, the amount of gain over and above the amount paid in is calculated as coming out first and will be taxed at 10% if the funds are taken out before the policy holder is 59 ½ years old.

If the insurance policy is not a modified endowment contract, you may borrow from the policy and not pay tax on the money that you have contributed to the policy.  If you cash out monies over and above what has been paid in, part of that that money is considered ordinary income.

Lapsed Policies

Some young adults allow their life insurance policy to lapse after they have taken a loan from the policy. The accumulated interest is considered taxable income.

Surrender Charges`

Surrender charges might happen if you withdraw cash from your life insurance policy. One of the best things to do is to take a policy loan from your insurance company. The cash value in the policy will be your collateral. If you repay the loan, the amount you borrow is usually not treated as taxable income. You will also avoid surrender charges since you aren’t withdrawing money. Interest on the loan is taxable.


The  subject of the taxability of life insurance is a complex one. The above is a sampling of what is involved in the tax liability for various types of life insurance. Please feel free to give me a call to set up an appointment, so that I can use my expertise to collaborate with you to find the perfect life insurance for you and your spouse.  Not only will you have an understanding of the worth of the policies, but you will also have a clear understanding of the tax situation involved with the various types of policies that you are considering.

Posted in Life Insurance, Tax on insurance., Taxes on Life Insurance., Texas Life and Health Insurance, Types of Insurance, Types of Life Insurance | 0 Comment