Is Life Insurance Taxable?

You know those stories about lottery winners spending all of their money, only to have to turn around and pay taxes they can no longer afford? Will the same thing happen when you receive your life insurance payout? It’s complicated.

So let’s talk about four different types of taxes which might come into play.

  1. Income Tax
    The IRS determines how much you’ve earned in a year, allows deductions, and determines how much you owe in taxes.
  2. Estate Tax
    Some states accumulate all of the assets of the deceased, subtract all outstanding loans, and tax the remaining amount from the estate.
  3. Inheritance Tax
    A few states tax the individuals receiving the inheritance themselves. Spouses are exempt. Children and domestic partners vary by local legislation.
  4. Generation-skipping Tax
    If money skips from a grandparent to grandchild, the trust or inheritance is taxable.

Most of the time, you don’t have to pay taxes when receiving a death benefit. Occasionally, you do. There are some key situations when life insurance Is taxable.

Here are a few…

  1. If three people are involved in the policy. If a father takes out an insurance policy on his son, which will pay out to the daughter-in-law, there are three people involved in the life insurance policy. This is taxable.
  2. When your estate tax exceeds the taxable threshold. If you skip a generation, and your insurance policy pays out to a grandchild, it is included in your “taxable estate.”
    If this is greater than $11.4 million, your insurance payout is taxable.
  3. If you sold the life insurance policy. If you sell your permanent life insurance not only will the agent take a portion, but when you receive the payout, it will again endure income taxation.

Although there may be some other circumstances under which you would owe additional taxes as well, these three are for certain.

If you need help determining whether life insurance should be part of your retirement portfolio – give Abich Financial Services a call!