Chelsey Tucker graduated with a Bachelor of History degree from Metropolitan State University in 2019. She now writes about insurance with her specialty being life insurance and has been quoted on Help Smart Phone and MEL Magazine.

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Dan Walker graduated with a BS in Administrative Management in 2005 and has been working in his family’s insurance agency, FCI Agency, for 15 years. He is licensed as an agent to write property and casualty insurance, including home, auto, umbrella, and dwelling fire insurance. He’s also been featured on sites like Reviews.com.

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Reviewed by Daniel Walker
Licensed Auto Insurance Agent

UPDATED: Mar 19, 2020

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Life Insurance TaxesNo, life insurance benefits are, for the most part, not taxable unless the actual amount the beneficiary receives is more than what the policy states. There are some exceptions. Those, and the ways the taxable amounts are calculated, are explained below.

The basic principle to remember when it comes to life insurance taxation is that life insurance death benefits are never subject to income tax unless the life insurance policy is deemed a Modified Endowment Contract (MEC) (more on that below).

One important consideration to remember is that just because life insurance death benefits are almost always federal income tax free the death benefit may still be subject to federal estate taxes.

Read on to learn some of the various scenarios where life insurance death benefits, distributions, capital gains, etc. may be subject to taxation and as always consult a qualified tax professional for any personal guidance.

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Learning the Scenarios that are Taxable

For example, if the stated benefit is $75,000 and the beneficiaries receive $76,000 in a lump sum due to interest, then only the $1,000 is taxable interest. As the beneficiary you would have to declare on that extra 1K on your taxes.

If a beneficiary receives the life insurance in payment installments, a set amount at regular intervals, then some of that amount will be taxed. If you take the benefit and divide it by the number of years you, or someone else, would receive payments then that is the amount that is not taxed.

Now, if you have a group-term life insurance policy (through your work, etc.) then anything over the first $50,000 of the coverage will be taxed if that coverage is carried by your employer in any way, either directly or indirectly. Anything over that has to be included in your yearly income, and you are expected to play taxes and social security on those amounts.

This is because the employer either pays part of the cost of the insurance policy, or arranges the premium payments through some kind of subsidizing and, by doing so, is affecting the cost of the policy’s premium. This is a benefit for employees, and is a taxable benefit for all proceeds over $50,000.

If the employer pays nothing of the cost, and all the employees pay the same amount through a third party, then the policy isn’t considered to being carried directly or indirectly by your employer. If this is the case, then there are no taxes on the money.

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Additional Factors

There are some other factors that can affect whether or not the life insurance benefits can be taxed. Most standard, termed life insurance policies that individuals buy on their own will not be taxed. If those premiums start getting rather high, however, you could face some taxes. For example, if you have a universal or whole life insurance, where part of the money is invested to give the policy a real cash value, there may be instances where benefits may be taxed.

For example, if the cash value of a universal life insurance policy becomes very high, it will turn into a modified endowment contract (MEC), and this can be taxed. An MEC happens when premium payments exceed amounts specified by the Internal Revenue Code.

Also keep in mind that your life insurance policy may be able to be included in with your estate taxes, if it is determined that you actually “own” the policy. Owning a policy means that you have the means to change the beneficiary at any time. To get around this, you can name the beneficiary and then put the policy into a trust you cannot change. Then, after three years, you won’t be considered as owning the policy and the policy will not be subject to estate taxes.

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Determining How Much Life Insurance to Buy

It can be a process to determine how much life insurance one ought to buy. That final number has a lot to do with how long you will be working before the policy ripens, current life style cost is, and what you would like to see happen with the money. You can get coverage that is twice your income, or you can get coverage for twenty times or more your current income. Then, once you get an idea about how much coverage you would like to purchase, figuring out what type of coverage you need is another process.

Term life insurance has different levels of premiums paid over set terms of 10, 20, or 30 years. The premiums fluctuate with these policies. Permanent life insurance (whole life or universal life insurance) policies have stable premiums which you can subsidize with a savings-account of sorts. The company will invest what you pay over the premium cost, which creates a cash value for your policy. The amount a beneficiary gets from any of these will likely not be taxed, assuming the amounts are rational (or at least not mammoth amounts of money), not even while the estate is being settled. These funds can get to you very quickly.

Life insurance is serious business. If you are looking for a policy in order to ensure specific things to those or for those you’ll leave behind, whether it’s quality of life, or peace of mind, or a certain amount of money that will help to give things a blank slate, consider all your options closely, so that you feel comfortable with your decision at the end of the day. Understanding how much of your life insurance benefits are taxable does a have a tangible effect on the bottom line of your policy payout.

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