Are Term Life Insurance Benefits Taxable?

Are Term Life Insurance Benefits Taxable?

Whether you’re a business or an individual, it’s always financially prudent to get the lowest tax liability legally possible. This requires an awareness of all the tax deductions and credits you may be eligible for. It’s probably why you’re wondering if term life insurance benefits are taxable.

Are Life Insurance Payouts Taxable?

Normally, the proceeds of your term life insurance policy aren’t subject to state or federal tax. The death benefit will go to your named beneficiary tax-free provided that it’s a lump sum, one-off payout. This is usually the case when your spouse is the beneficiary, as there’s no point in breaking up the payment into smaller installments.

Are Accelerated Death Benefits Taxed?

This question arises from the fact that some term life policies can pay out living benefits to the policyholder under specific circumstances. For example, a portion of your death benefit may be available out of necessity if you develop a terminal or chronic illness. The funds can help settle your medical and hospital bills, which are unusually high when it comes to severe life-threatening illnesses. According to the law, accelerated death benefits are not taxable as the policyholder is treated as the beneficiary from a tax perspective.

When Are Term Life Insurance Benefits Taxed?

A life insurance death payout may be taxed in various scenarios. These include:

  • Payment is made in installments:

    Sometimes, the beneficiary receives the payment in multiple smaller amounts over a period of time. For example, a parent may prefer that the death benefit be paid to their young children in installments. In that case, the insurer keeps the money in an interest-accruing account for a specified number of years. Since the interest is a form of income, it’s subject to income tax.

  • Your estate is the beneficiary:

    If the death benefit is paid out to your estate, then the person that inherits the estate might have to pay tax on it. The tax liability will be triggered if the total value of your estate exceeds the federal threshold of $11.7 million. This is why it’s essential to carefully consider how the value of your estate might be impacted before naming it as your life insurance policy’s beneficiary. However, your spouse’s inheritance isn’t subject to estate tax even when the proceeds exceed the federal limit.  

Taking Advantage of an Irrevocable Life Insurance Trust (ILIT)

Paying out a death benefit to your estate doesn’t always have to increase your tax liability. However, you need to create an irrevocable life insurance trust and transfer the policy ownership to it. As the policyholder, you cannot be the trustee, but you can choose your trust beneficiaries. This way, the beneficiaries won’t have to pay taxes on the proceeds as part of your estate. The strategy is legal and highly effective, but it doesn’t rule out the possibility of facing a tax event.

For example, any proceeds from the policy may be taxable as part of your estate if you die within three years of transferring the coverage to an ILIT. Tax law makes this provision to discourage policyholders from using deathbed gifts to shield their heirs from estate tax obligations.

Who Is Eligible for Insurance Premium Tax Deductions?

As an employer, the premiums you pay toward the first $50,000 worth of group term life coverage per employee are tax-deductible insurance expenses. However, any extra life insurance costs for coverage above $50,000 would be taxable employee income.

Term life insurance is an ideal way to secure your loved ones’ financial future with minimal tax liabilities. For any questions about these policies, contact our experienced team at Udell Family Insurance today. We can create a life insurance plan that’s right for your financial objectives.

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