Are life insurance proceeds taxable?
When the policyholder of a life insurance policy passes away, the proceeds, or death benefits, are paid to the named beneficiary or beneficiaries.
In general, the payout from a term, whole, or universal life insurance policy isn't considered part of the beneficiary's gross income. This means it isn't subject to income or estate taxes.
However, there are some cases when a death benefit can be taxed. Here are a few examples
- Payout structure. Life insurance proceeds paid in a lump sum are generally received by the beneficiary tax-free. This includes term, whole, and universal life insurance. However, if the payout is set up to be paid in multiple payments the payments can be taxable.
For example, an annuity is paid regularly over the life of the beneficiary. The payments include proceeds and interest. These payments can be subject to taxes.
- Policyholder has withdrawn money or taken out a loan. Some life insurance policies such as whole life, have the benefit of earning cash/interest over time. These excess funds can then be withdrawn or taken out as a loan against the policy. However, if the money withdrawn or loaned is more than the total amount of premiums paid, the excess may be taxable.
- Surrendering your policy. If you have a life insurance policy you no longer need or want, you may surrender your contract. Typically, the amount you paid into your policy (the cash basis) that you get back when surrendering your policy is considered a tax-free return of your principal. However, any funds over your policy's cash basis will be taxed as regular income.
- Employer-paid group life plan. In some cases, an employer-paid plan that pays out more than $50,000 may be taxable according to the Internal Revenue Service (IRS). Otherwise, the death benefit is paid to beneficiaries tax-free.
- When a death benefit and the total value of the deceased's estate exceeds limits. According to the IRS, if life insurance proceeds are included as part of the deceased's estate and together, exceed the federal estate tax threshold of $12.92 million (as of 2023), estate taxes must be paid on the proceeds over the allowed limit.
