[vc_row][vc_column][vc_single_image image=”4523″ alignment=”center” border_color=”grey” img_link_large=”” img_link_target=”_self” img_size=”full”][vc_column_text]There’s no doubt about the importance of life insurance in general. It’s a safe-guard against otherwise overwhelming difficulty, and a blanket of security in the event of loss or tragedy.
But many people are still unsure about how they’re supposed to handle life insurance proceeds in the event of a loved one’s death.
Particularly in terms of taxation.
So What’s The Bottom Line?
Generally speaking, life insurance proceeds paid to you as beneficiary of the insured individual are not subject to federal income tax, unless the policy was turned over to you for a price. They aren’t considered gross income, so they don’t need to be reported.
But to qualify for any favorable treatment, the first major obstacle to overcome is one of definition: What is life insurance? Taxable incomes are dependent upon a number of defining features and characteristics.
This is where it gets a bit more complicated.
The Contract Has To Meet Certain IRS Requirements.
According to the IRS, a life insurance contract will not qualify for favorable tax treatment unless it meets state requirements, as well as the statutory federal criteria for defining what is – or is not – a life insurance policy in the first place.
The IRS will consider:
- Policy Type.
- Issue Date.
- Death Benefit Amount.
- Premiums Paid.
Insurance companies are required to comply with all federal regulations, and must enforce the identified provisions in order to issue contracts. Think of them as tests. They were instituted to verify that an insurance contract isn’t really an investment vehicle in disguise.
An Area Of Interest.
So we’ve passed the first major test. Now it’s time to consider the boundaries of legitimate life insurance contracts – as the interest income you receive may be taxable.
Lump Sums – If benefits are paid out to you in a single sum (or otherwise irregular intervals), include as taxable income those benefits greater than the “amount payable to you” at the time of your loved one’s death. If that amount wasn’t specified, include amounts greater than the present payment value at the time of death.
Installments – If you receive sums in installments and interest is paid, the interest on the payment generated after the insured individual’s death is considered taxable income. It’s taxed at your regular income rate.
However, the portion of the payment considered “investment in the contract” is not taxable.
To calculate the amount you may exclude, simply divide the amount held by the insurer (usually the amount of the lump sum payable upon the insured individual’s death) by the number of installments you’re to be paid. Anything over this excluded portion is to be considered interest.
- If you’re entitled to receive proceeds in installments for the rest of your natural life – without a refund or period guarantee – you calculate the excluded part of each installment by dividing the amount the insurer holds by your life expectancy.
Remember to report life insurance interest just as you would any other interest you receive.
Just One More Thing.
Certain federal income tax regulations apply to accelerated death benefits (such as death due to terminal or chronic illness, for example) and to other types of benefits paid before the insured individual’s death (withdrawals, policy loans, dividends, etc.).
So, Is Life Insurance Taxable? Or Is It Not?
We hope we’ve simplified things. Pouring over the guidelines and limitations imposed by federal and state regulation may be tiresome – but the insight is invaluable.
Well, maybe it is valuable. But that’s the point.
To find out more about what portions and percentages of life insurance proceeds are taxable and non-taxable, or if you still have some unanswered questions, just reach out to a professional.
We’d be glad to walk you through it. It’s what we do.[/vc_column_text][/vc_column][/vc_row]