- Life insurance death benefits paid to a beneficiary are generally not subject to federal income tax.
- Estate tax can apply if you own a policy and your estate is large; thresholds change with the law.
- Interest, policy loans, surrenders and ownership transfers can create tax consequences.
People often worry that taxes will eat into a life insurance payout. For most families, the good news is that the death benefit is not taxed as income. But there are exceptions and related issues worth knowing, especially if you own permanent insurance, have a large estate or plan to borrow against a policy.
Income tax on the death benefit
In general, a death benefit paid to a named beneficiary because of the insured person's death is not subject to federal income tax. The beneficiary usually receives the full amount without reporting it as income. States have their own rules, and most follow the same approach for income tax.
The interest exception
If the insurer holds the proceeds and pays them out in installments, or pays interest because of a delay, the interest portion is generally taxable. The death benefit itself is not.
Estate tax
Estate tax is a different issue. If you own the policy on your own life when you die, the death benefit is generally counted as part of your taxable estate. For most families this does not matter, because the federal estate tax applies only to estates above a high threshold, well into the millions of dollars per person, which changes with the law. Some states have their own estate or inheritance taxes with lower thresholds.
People with larger estates sometimes use an irrevocable life insurance trust, or ILIT, which owns the policy so the death benefit is kept out of the taxable estate. This is a job for an estate attorney, and it has strict rules.
Premiums
For personal life insurance, premiums are generally not tax-deductible. There are exceptions in certain business arrangements, which an accountant can explain.
Permanent policies: cash value
With whole life and other permanent policies, cash value grows tax-deferred. That means you generally do not pay tax on the growth while it stays inside the policy. Tax can arise in several situations:
- Surrendering the policy: the part of the payout that exceeds the premiums you paid can be taxable.
- Withdrawals: usually taxed once they exceed what you paid in.
- Policy loans: generally not taxed while the policy stays in force, but if the policy lapses with an outstanding loan, it can trigger a tax bill.
Term life has no cash value, so these issues do not apply. See term vs whole life for how the two compare.
Selling or transferring a policy
Transferring a policy to someone else in exchange for money can cause some or all of the death benefit to become taxable. If you are considering this, get professional advice first.
Employer-provided coverage
If your employer provides more than $50,000 of group term life coverage, the IRS generally treats the cost of the coverage above $50,000 as taxable income to you. Your payroll or HR team can tell you whether this applies. See group life insurance through work.
When to talk to a professional
- You own a large policy and have a substantial estate.
- You plan to borrow against, withdraw from or sell a permanent policy.
- You live in a state with its own estate or inheritance tax.
- The policy is part of a business arrangement.
For most people buying term life to protect their family, the takeaway is simple: the money your beneficiaries receive is usually not taxed as income. When you are ready to claim, our guide on how to file a life insurance claim explains the process.