Taxes are top of mind this time of year. So if you’re considering life insurance, now is a great time to evaluate its tax benefits so you’re aware of what you’ll be dealing with down the line.
For term life insurance customers, there’s good news – term life insurance payouts (also called “death benefits”) are generally not subject to federal income tax, according to Internal Revenue Code (IRC) Section 101(a). This is because these payouts are considered reimbursement of a loss, and not income . This means beneficiaries who receive payouts from a policy can use all of the payout to pay off debt, offset lost income and maintain a family’s current lifestyle. Also, term life insurance payouts are often exempt from state inheritance taxes as well.
While any death claims for permanent life insurance products are also not subject to federal income tax, the tax advantages of the savings component, or “cash value” portion of permanent life insurance can vary. Care should be taken when evaluating the tax benefits of permanent life insurance as the rules can be complex, so make sure you know the facts.
Although an individual’s term life insurance premiums are not tax deductible, when it comes to transferring wealth, estate, generation-skipping transfer tax and gift tax rules usually look kindly on “death benefit” payouts:
- Benefits paid out to a surviving spouse who is a US citizen qualify for the marital deduction and should not be taxed, according to IRC Section 2056.
- Benefits payable to other beneficiaries should not be considered part of the insured’s taxable estate, as long as the person insured did not have an “incident of ownership” in the policy in the three years prior to death (IRC Sections 2042 and 2035).
- Premiums paid by the policyholder are not treated as taxable gifts.
At Ladder, we’ve redesigned the life insurance process to be smart and simple with our customers at the center of everything. We believe term life insurance is a smart choice for our customers. A tax-free payout is just one of the many reasons we love term life insurance.
If you have any questions for us, we are always happy to help.
This material is designed to provide general information on the subjects covered. It is not, however, intended to provide specific advice or to serve as the basis for any purchasing decisions.