There are many things to consider when it comes to life insurance. People often have a lot of questions regarding purchasing a policy. Getting answers to these questions is vital for making the best choice. If you are wondering about the tax implications of life insurance, it is imperative you educate yourself on the matter before purchasing a policy.
Taxation May Occur
Is life insurance taxable? While in most cases the death benefit to the beneficiary is not taxable, there are some tax implications that can occur. Before purchasing life insurance, it is wise to fully understand any tax implications that could arise so your beneficiaries will be properly prepared.
There are three main scenarios that could cause the death benefits from a life insurance policy to become subject to taxes. The following are some of the instances.
- Estate tax triggers
- Accelerated death benefit rider
- Interest on death benefits
Estate Taxes and Death Benefits
Term life insurance payouts could become taxable if they are paid to the estate instead of directly to the beneficiary. As of right now, the estate tax kicks in when an estate is valued over $11 million. Thankfully, there are ways to avoid this tax by using different strategies. One of the strategies is transferring the life insurance policy to an irrevocable trust.
Accelerated Death Benefit Rider
If you choose to activate the accelerated death benefit rider, there is a chance the benefits could become taxable. In most cases, this rider can be added to a life insurance policy at an added cost. This rider is for terminally ill individuals. Before their death, the individual may have the right to have access to a portion of the policy’s death benefits. If you choose to access these benefits, they are counted on a 1099 LTC and filing this form could result in taxes being charged for the amount.
Interest on Death Benefits
In most cases, death claims are not filed on the same day as the death. Sometimes, weeks have passed before the filing occurs, leading to interest and premiums. In most cases, the life insurance company not only pays the death benefit, but they also pay back any interest or unearned premiums since the date of death. The unearned premiums are not taxable, but the interest is and could lead to a tax bill.
Other Tax Implications
There are also some other scenarios that could lead to tax implications. Some life insurance policies allow you to receive installment payments instead of a lump sum. Each payment includes a portion of the death benefit and interest. The death benefit is not taxable, but the interest paid by the insurance company is taxed.
Your insurance company may also offer the option of keeping the payout on deposit. If the beneficiary does not need the money right away, they can choose this option and gain interest as the money sits in a deposit. The insurance company will send you a 1099 each year on the amount of interest that was earned on the benefit deposit. The beneficiary will need to report the interest as income, even if they do not withdraw any money from the account.
Consider Your Options and Choose Wisely
There are many things to consider when it comes to purchasing life insurance coverage. Researching your options and carefully weighing them before making a decision is essential. It is wise to take time in the process and discuss the options with your beneficiaries before you make a purchase.
While term life insurance is the most affordable choice, there are many others. The following are some of the options for life insurance.
- Permanent life insurance
- Universal life insurance
- Variable life insurance
- Simplified issue life insurance
- Variable universal life insurance
- Guaranteed issue life insurance
- Whole life insurance
No matter the type of life insurance policy purchased, there are sometimes tax implications. The death benefit is rarely taxed, but the above scenarios can lead to taxation in certain circumstances. Most people consult with an accountant before making any decisions on life insurance so they will be aware of any tax implications that may arise.
Is life insurance taxable? While the simple answer to the question is no, there are some tax implications in certain situations. Before accessing a rider, or making choices on the death benefit payout, it is wise to consult with an accountant to ensure you are making the right choice before purchasing.
Protecting your loved ones with a life insurance policy should not bring on stress and worry related to taxes. When the right tax strategy is chosen, you can often avoid taxes and ensure your beneficiaries are not saddled with a bill. Carefully check out your options and learn as much as possible before choosing any type of life insurance policy.