What Is the Tax Percentage on Life Insurance?

In most cases, life insurance death benefits handed out in a lump sum to a beneficiary are not considered income to the recipient of the life insurance payout. Death benefit payments given under endowment contracts, worker's compensation insurance contracts, employer's group plans, or accident and health insurance contracts are also exempt from taxes.

Image: Pixabay

Taking It Apart

Although the death of a loved one cannot be planned or predicted, working with a professional tax and estate planner can help you avoid the IRS collecting where they don't have to. As a result, rather than being a "how-to" guide, this article should be used as a checklist to ensure that your life insurance policy is in the proper place. It's fine to double-check with your estate planner to make sure your insurance payouts go to the appropriate people.

Taxes on Interest Paid in Excess

The exclusion does not apply if a policy is paired with a non-refund life annuity contract with a single premium equal to the face value of the insurance paid. For example, if the face value of the death benefit is $250,000 and the beneficiary opts for monthly installments rather than a lump sum payment, the excess interest received over the $250,000 face amount is taxable.

In contrast to life insurance, the amount of taxes owed by an inherited annuity recipient might vary depending on the annuity contract's structure and whether the beneficiary is a surviving spouse. If the inherited annuity was part of the decedent's defined contribution plan, such as a 401(k), then the SECURE Act may apply to when the recipient can take distributions and the amount of taxes owing. Because annuity rules can be complicated, it's crucial that you speak with an experienced tax professional about your tax obligations.

Ownership and Estate Planning Complications

While life insurance death payments are normally exempt from income taxation for the beneficiary, they are included in the dead's estate if the deceased was the policy's owner at the time of death. The benefit paid may be liable to federal and state estate taxes as a result of its inclusion as part of the estate. The IRS will still consider the deceased as the policy owner for estate tax purposes if the owner of the life insurance policy is someone other than the deceased. This assignment must have occurred more than three years prior to the date of death, or the IRS will still consider the deceased as the policy owner.

Final Thoughts

Although a life insurance policy's beneficiary is not taxed by default, it is critical to double-check with your financial adviser that your investments are in the appropriate place.

Avoiding the aforementioned blunders can save you tens of thousands of dollars in taxes.