Is Life Insurance Taxable?
Talking about why we need life insurance policies can be uncomfortable for some. But at Farm Bureau Insurance of Tennessee, we believe that there’s no greater act of care and compassion for your loved ones than offering them a safety net in the event of your death. A life insurance policy can help secure your family’s financial future, which can give them peace of mind during a difficult time and allow them to live life as they are accustomed.
If you choose a life insurance policy, something that’s just as important as choosing the right one is making sure that you and the loved one you name as your beneficiary understand how the policy works. While of course your Farm Bureau Insurance agent will be there to guide and advise beneficiaries should they need to collect the benefit, it will ease an already stressful time if your loved one already knows the ins and outs of the policy.
One question many people ask: Is life insurance taxable? In this blog, we’ll break it down for you.
Is life insurance taxable?
Life insurance payouts—called a “death benefit”—are typically not taxable. In most cases, your loved ones will be able to receive your policy’s worth without having to pay taxes on it. There are some situations where the death benefit may be taxed, though.
When Life Insurance Benefits Might Be Taxed
While most of the time death benefits are not taxable, there are certain circumstances where they may be. Here is a closer look at some situations where the answer to “Is life insurance taxed?” may be a yes.
The policy doesn’t have a beneficiary. If you don’t name a beneficiary for your life insurance policy, it will go into your estate and can be taxed like any other part of the estate. You can avoid the hassle this may cause your loved ones by naming both a primary beneficiary and a contingent beneficiary (who would receive the death benefit if both you and the primary beneficiary passed).
You take out a loan against your policy’s cash value and the policy ends. Some life insurance policies allow you to take out a loan against their cash value. That loan isn’t taxable—unless the policy ends or you experience a lapse in coverage before you repay the loan.
You surrender your policy. If you don’t want or need your policy anymore, you can take the “surrender value” of the policy, or the current cash value minus any surrender fees. The surrender value is taxable if it is higher than the amount you’ve paid in premiums so far. Keep in mind that surrendering your policy means your insurer will cancel it, and beneficiaries will not receive a benefit when you die.
You sell your life insurance policy. If you sell your life insurance policy in what’s called a life settlement, you typically receive a one-time cash payment. Part of the life settlement may be taxable. The third party who bought your policy—usually a company—will continue paying the premiums and receive the death benefit when you die.
Three people are named in your policy. We’ve been saying “your life insurance policy” to refer to a policy you purchased to insure yourself. But that’s not always the case. When it comes to life insurance, there are three roles: the policyowner (whoever purchased the policy and is responsible for paying premiums), the insured (the person whose life the policy covers), and the beneficiary (the person who receives the death benefit when the insured dies). If the policyowner and the insured are different people—say, you buy a policy to insure your spouse—then there may be gift tax implications for the death benefit. If this is something you’d like to avoid, you can do so by having the policyowner and the insured be the same person.
Planning Ahead
If this all seems a bit complicated, you can always talk with a tax professional about any potential tax implications and about actions you’d like to take with your policy. Our friends at Farm Bureau Tax Service would be happy to help you. You can also take a look at this interactive tax assistant tool from the IRS that’s built to help you answer “Is my life insurance benefit taxable?”
And if you have questions about your policy itself—or what type of policy you ought to consider, from term to whole—you can always reach out to your local Farm Bureau Insurance agent to discuss. Connect with one today.
