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Do I Have to Pay Taxes on Life Insurance? What You Need to Know

In most cases, life insurance proceeds are not subject to income or estate taxes. Learn more about taxes and life insurance in this guide.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

Life insurance policies can prove invaluable for beneficiaries. While nothing will be able to replace the loss of a loved one, the payout on a life insurance policy can ease many financial burdens. With such a large sum of capital changing hands, however, many beneficiaries find themselves asking the same question: is life insurance taxable?      

With so much money on the line, beneficiaries need to learn the taxation guidelines for life insurance. As a result, we’ve put together this guide to help answer all of your questions related to how life insurance proceeds are taxed. Read on to get all your questions answered and more!

Is Life Insurance Taxable?

It is a simple question: Is life insurance taxable? Fortunately, the answer is relatively simple: not for most beneficiaries. The majority of named beneficiaries on life insurance policies won’t have to report their death benefit earnings as income on their taxes. Or, as the Internal Revenue Service so eloquently puts it, “Generally, life insurance proceeds you receive as a beneficiary due to the death of the insured person, aren't includable in gross income and you don't have to report them.” That means the majority of beneficiaries won’t have to pay taxes on the money they receive from a life insurance policy. 

It is worth noting, however, that there are exceptions to every end-of-life plan. While most beneficiaries won’t have to pay taxes on life insurance, some situations may require death benefit recipients to pay taxes on some or all of the proceeds. Having said that, the key isn’t to know if proceeds are subject to taxes, but rather when they are. 

It is not enough to simply know the answer to the question “is life insurance taxable.” In order to truly understand the taxation guidelines for life insurance, you’ll need to know when proceeds are taxed. Therefore, instead of asking yourself “do you have to pay taxes on life insurance,” you should be asking yourself something far more important: When is a life insurance payout taxable?      

Do You Have to Pay Taxes on Life Insurance?

The overwhelming majority of beneficiaries won’t have to pay income or estate taxes on their death benefit payouts. However, there are circumstances that will call for payouts to be taxed. 

Life insurance proceeds may be subject to income and/or estate taxes if:   

  • They are left in an estate plan, and the proceeds cause the estate’s worth to exceed $12.06 million ($12.92 million in the 2023 tax year).

  • The death benefit is paid in installments which accumulate interest. 

  • The insured individual, the policy owner, and the beneficiary are all different (usually the insured individual and policy owner are the same).

When asking yourself “is life insurance taxable,” all you need to do is determine whether or not the death benefit falls into one of the categories listed above. For more detailed information on why you may have to pay taxes on life insurance, please keep reading.

Do Beneficiaries Pay Taxes on Life Insurance Policies?

One of the best reasons for taking out a life insurance policy is that the death benefit is usually bequeathed to beneficiaries without being subjected to income or estate taxes. While it may seem small, the incentive can amount to thousands of dollars and a lot more financial support for loved ones.

Of course, there are extenuating circumstances which may call for proceeds to be taxed. Beneficiaries may have to pay taxes on proceeds if any of the following situations occur:

  • The beneficiary receives the payout in installments: Do beneficiaries pay taxes on life insurance policies if they elect to be paid in installments? In a word: yes. Otherwise known as an annuity, these installments are paid in smaller increments over a predetermined period of time. The principal amount — from which the installments originate — is typically held in an interest-bearing account, where the original death benefit can accumulate interest. While the original death benefit won’t be taxed, the interest paid out in each installment will be subject to income taxes.

  • The death benefit exceeds the federal estate tax exemption when left to an estate: In the event the death benefit is bequeathed to an estate, and the resulting value of the estate exceeds $12.06 million ($12.92 million in the 2023 tax year), the IRS will levy an estate tax in most states. Unfortunately, heirs will be responsible for paying estate taxes on any assets above the tax exemption threshold. That said, anything less than $12.06 million in the current tax year will render this estate tax moot.

  • The IRS considers the proceeds to be a gift from the policy owner to the beneficiary: Most life insurance policies consist of a policyholder and a beneficiary. For example, it is common for a parent to buy a policy that their child will receive upon their death; in that case, the death benefit isn’t subject to income or estate taxes. However, if the insured person and the policyholder are different people, the IRS may view the death benefit as a gift and tax the payout. If, for example, one spouse buys a life insurance policy for their significant other to bequeath to their child, the policy is technically a gift, and will be taxed as such.  

Update Your Estate Plan to Include Life Insurance Today

Few financial vehicles provide a greater “peace of mind” for more people than life insurance. On one hand, policyholders may take solace in the fact that their ability to provide financial security for loved ones will persist. Beneficiaries, on the other hand, may be able to sleep better at night when they learn lost income can be replaced by a death benefit. That said, the last thing any policy holder wants to do is saddle their loved ones with unwelcome taxes.

Instead of asking yourself “is life insurance taxable,” and leaving the financial security of your loved ones in limbo, enlist the services of a professional to make sure your final wishes are heard. Here at Trust & Will, we’re here to help keep things simple. You can create a fully customizable, state-specific estate plan from the comfort of your own home in just 20 minutes. Take our free quiz to see where you should get started, or compare our different estate planning and settlement options today! 

Is there a question here we didn’t answer? Browse more topics in our learn center or chat with a live member support representative!

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