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 TaxesThe proceeds of a life insurance policy are, for the most part, not taxable, according to the IRS. However, there are certain situations whereby a portion of the proceeds are taxable.

If you receive all the proceeds in one payment following the death of the insured, the proceeds are not taxable.

However, any portions of life insurance benefits that are in reality interest on the original proceeds are taxable.

For this reason, receiving installments instead of a lump sum payment typically means declaring your life insurance proceeds and paying tax on a portion of them.

It is also worth mentioning that generally the death benefit proceeds of a life insurance policy are income tax free but they may still be subject to estate taxes (the so called “death taxes” from the Federal government that usually only applies to larger estates). If you want to compare life insurance quotes from many different life insurance companies just enter your zip above!

When Life Insurance Is Taxable

Life insurance benefits are one of the very few cases of income that are tax-free and do not need to be reported to the IRS on your income tax form. Yet, as with every good thing, there is a catch. There are some very specific situations which will cause you to have to pay tax on your proceeds as the beneficiary of a life insurance policy.

If you have an employer-owned life insurance policy, chances are that any proceeds will be taxable beyond the equivalent of your contributions to it. With many such policies, the employee will pay a portion of the annual premium and the employer will pay the remainder. If this is the case, the beneficiaries will only have tax-free income on the portion paid by the employee.

If you decide to cash in your life insurance policy and terminate it, you will need to pay tax on any amount that exceeds what you invested into it. Your premium payment total will be returned tax-free, but any interest earned and paid out to you will be taxable. It works exactly the same way as any investment.

The way in which beneficiaries are paid makes all the difference in the tax laws concerning a life insurance policy. If you opt for installments for life or any other type of installment payment plan, you will end up paying taxes on the amount of money beyond the original settlement, which would have been made immediately after the insured’s death.

Excess money paid after this time is considered interest and is therefore taxable. The only way you would have an additional break on your taxes is if the insured died prior to October 23, 1986. In this case, there is an additional $1,000 tax deduction that you can take off the interest paid to you.

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How to Avoid Taxation on Life Insurance Proceeds

Avoiding taxation on life insurance proceeds is relatively easy. In most situations, such proceeds are automatically tax-free. Therefore, you simply need to ensure that you take the payment in the most tax advantageous way possible. Upon learning that you have become a beneficiary to a life insurance policy following the death of a loved one, take possession of the policy proceeds at once in full, to avoid taxable interest. You should know that any form of installment payment will make a portion of the proceeds taxable.

If you have already set up an installment payment plan for proceeds from a life insurance policy, you can attempt to change the policy and receive the remaining benefits at one payment. You can then make investments which can prove to be tax shelters with the money you receive in order to avoid further taxation on that income.

Finding the Right Life Insurance Policy

You can easily find the right life insurance policy that covers your needs by shopping around with the use of a free online quote tool. Since life insurance benefits are typically tax-free, it is an excellent way to make sure your loved ones are taken care of and are not penalized in the same way estate taxes diminish their inheritance. Get started with an online quote tool by answering questions about your health and life insurance requirements and in no time you will have a variety of quotes from different companies to compare and choose from.

Once you have the quotes you need, be sure to check out the companies you are considering doing business with. Your state department of insurance keeps track of customer complaints on each insurer. You can learn about the customer service record of an insurer by doing an online search. To find out about the financial stability of a company, get its ratings from one of the independent insurance ratings firms like A.M. Best or Moody’s.

Start today finding the right policy using a life insurance quote tool that shops around for you. Just enter your zip to start now!