Understanding Taxes on Life Insurance Distributions: A Guide for Policyholders

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For those with a good life insurance policy, it’s a relief to know they can leave a nice death benefit behind for their spouse, children, and other loved ones. However, the arm of the IRS is very long, and if you’re not careful, your beneficiaries may get unexpectedly taxed for your payout. 

How does this work, and is your life insurance taxable? Keep reading to learn everything you need to know about life insurance tax! 

Is Life Insurance Taxable? Yes, No, Maybe So — Let’s Break It Down 

At this point, your beneficiaries might have one big question: “Do you pay taxes on life insurance?” The answer is that it depends. Specifically, it depends on how your beneficiaries choose to receive the money! 

Most recipients choose to receive their money in one lump sum. In that case, they most likely won’t have to pay anything to the IRS. However, some recipients choose to receive their payout as an annuity. The obvious benefit to such a plan is that it keeps a steady stream of extra income coming in for many years. However, there is one big downside: For those who receive their benefit this way, any interest that the annuity gathers over time may be subject to taxes. 

Are There Taxes If You Surrender Your Policy? 

Now you have a firm answer to the question, “Are life insurance proceeds taxable?” However, that leads us to the next question: If you decide to surrender your policy and receive a cash payment from your carrier, will you have to pay any taxes on the money you receive? 

Once again, the answer will depend on your specific circumstances. For example, if the amount of the policy you are surrendering is greater than the cumulative premiums you have paid, then the excess amount may be taxed by the IRS. But if the amount of the policy is less than the cumulative premiums, then you won’t have to worry about taxation. 

Whether or not you have to pay taxes on the cash you receive for a surrendered policy, keep in mind that insurance carriers reserve the right to charge you a surrender fee. That may or may not be a deal breaker, but it has the potential to cut into the amount of money you receive from the carrier. 

Will I Be Taxed If I Sell My Policy? 

In most cases, those who are no longer interested in their life insurance coverage simply surrender the policy back to the carrier. However, you do have the opportunity to sell that policy to a third party. Once again, whether you pay taxes on the policy you are giving up depends on the exact details of that policy. 

If you receive more from the sale than you paid via cumulative premiums over the years, then you may have to pay taxes. As always, you should consult with your carrier before attempting to sell your policy to a third party. 

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Life Insurance and Estate Taxes: How They Interact and What You Need to Know 

Many people who purchase a life insurance policy intend for the death benefit to be the primary payout for their beneficiaries after their death. However, if you are wealthy enough to require extensive estate planning for your beneficiaries, you should know that the amount of money they receive via your policy may affect whether or not they are taxed by the IRS. 

For example, as of 2024, the federal government has a threshold of $13.61 million. If the value of what you leave behind exceeds that amount, your heirs will need to pay estate taxes. The death benefit counts toward this overall value, so in certain cases, a life insurance policy could make the difference in whether someone has to pay estate taxes or if it pushes the overall value past the IRS threshold. 

On top of the federal taxes, it’s important to research whether your state has any of its own rules regarding estate planning or inheritances. It’s entirely possible that your beneficiaries may not have to pay any estate taxes to the federal government but will still end up owing some amount of money to the state. 

Do You Have to Pay Taxes on Employer-Provided Life Insurance? 

It’s generally advisable to purchase a separate life insurance policy on your own. However, many people receive such a policy through their employer. Whether beneficiaries will have to pay taxes on payouts from employer-provided policies comes down to the amount of coverage you have. 

In short, policies where the death benefit is less than $50,000 will not have their payouts taxed. But policies where the payout is $50,000 or more may be taxed by the IRS. 

Get the Best Life Insurance Coverage Today! 

Now you know all about whether your life insurance is taxable. But do you know where you can get the kind of coverage that your family truly needs? 

Here at InsureOne, we know how important your family is to you. That’s why when you’re ready to get the kind of coverage that will protect them long after you’re gone, we’re ready for you to get a quote online. Alternatively, you can pick up the phone and give us a quick call at 800-836-2240. Finally, feel free to come into one of our convenient nearby offices for a face-to-face chat.