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Is term life insurance taxable?

Many people wonder if the proceeds from a life insurance policy are taxable to the beneficiary. The short answer is that most of the time, no they are not.

If you have loved ones who depend on you financially, you need life insurance. Why? The answer is simple.

A life insurance policy payout will help your loved ones continue to pay the bills and cover your funeral expenses when you’re no longer there to support them. “You need to provide for them at the end of your life,” says Sean Mullaney, a Certified Public Accountant and president of Mullaney Financial and Tax.

Because a life insurance death benefit can be a lifeline for families, federal and state tax law is designed to protect insurance payouts, Mullaney says. That’s right – even though nothing is certain except death and taxes, death benefits usually escape taxes.

However, there are a few instances when a life insurance death benefit could be subject to taxes. It’s important to be aware of these situations to limit the tax liability of a life insurance payout.

Why life insurance proceeds are usually not taxable

There are two primary types of life insurance, term and permanent life insurance.

With term life insurance, coverage lasts for a specific number of years and is typically one of the more affordable types of life insurance. For example, a healthy 30-year-old woman could purchase a 20-year Haven Term policy, issued by MassMutual, with a $250,000 benefit for starting at $14.99 a month. If you die during the term of your policy, your beneficiaries can file a claim with the insurance company to collect the death benefit.

Permanent life insurance provides coverage that lasts a lifetime, as long as the premiums are paid.

Payouts from either of these types of life insurance are generally not taxable to beneficiaries.

“If you look at the Congressional committee reports from the early 20th century pertaining to this provision of the income tax code, you’ll see that there is this strong concern for ‘widows and orphans,’” says Logan Allec, a CPA and owner of personal finance site Money Done Right. “So this exemption of life insurance proceeds is really rooted in social concerns, and this exemption has persisted to this day.”

How death benefit payment options might affect taxability

Life insurance companies typically offer a few different options to receive the death benefit payout from a policy. The default option is a lump-sum payment, which is generally tax-free.

However, if you or your beneficiaries choose to receive a payout in installments over time, a portion of these payments could be taxable.

“If you receive life insurance proceeds in separate payments over time, and the sum of these installments is greater than the amount you would have received from the insurance company if you had merely taken a lump sum upon the death of the insured, then a portion of these payments to you is considered interest,” Allec says. That interest can be taxed at your ordinary income tax rate.

You should receive a Form 1099-INT from the insurance company reporting your taxable interest, Mullaney says. You also could be hit with an additional tax on that interest if you are a high income earner.

Single taxpayers with a modified adjusted gross income (MAGI) of $200,000 or more and married taxpayers filing jointly with a MAGI of $250,000 or more must pay a 3.8% net investment income tax – also known as the Medicare surtax – on investment income such as interest.

Estate taxes and life insurance payouts

People with a large life insurance death benefit used to be worried about the estate tax, Mullaney says. That’s because the limit on assets – including insurance – that could be passed onto heirs tax-free was much lower than it is now.

For example, in 2004, an estate tax return had to be filed for estates exceeding $1.5 million, according to the IRS. For 2020, a federal estate tax exemption covers estates up to $11.58 million. “If you have a term life policy and it’s included in your estate, you don’t have to worry about the estate tax most likely,” Mullaney says.

If you have a large estate, though, Allec suggests working with a tax planning professional to discuss tax minimization strategies.

To keep your insurance payout out of your estate, “it may be advisable to transfer your policy’s ownership to someone else, perhaps the beneficiary,” Allec says. “Another strategy is to transfer the ownership of your life insurance policy to an irrevocable life insurance trust, where the proceeds of a life insurance policy may be insulated from estate taxes, subject to certain requirements. Again, work with a tax planning professional to see what may suit your specific situation.

Accelerated death benefits and taxes

Your life insurance company might offer an accelerated death benefit rider – a rider that can be added to your policy that would allow you to collect a portion of your death benefit while you’re alive to pay for medical care if you’re terminally ill. There can be an additional charge for this rider, but with the Haven Term policy, issued by MassMutual, it is included in the policy, and an administrative fee is charged if the rider is exercised.

Generally, you can receive accelerated death benefits tax-free if you have been certified by a doctor as terminally ill and are expected to die within 12-24 months (depending on the terms of the policy). If you are chronically – but not terminally ill – you still can qualify for the tax exclusion if you use payouts for qualified long-term care expenses, Mullaney says. Ask your tax planner about exceptions that may exist.

Cash value payouts and taxes

Permanent life insurance policies have a cash accumulation feature. In addition to offering the death benefit, these policies build cash value over time that can be tapped while you’re alive. However, borrowing against cash value increases the chances that the policy will lapse, reduces the cash value and death benefit, and may result in a tax bill if the policy terminates before the death of the insured. Additionally, participating policies have the potential to receive dividends, however it’s important to note that dividends are not guaranteed.

The primary reason to buy life insurance is the need for the death benefit. But in addition, permanent life insurance policies can also be used to supplement income in retirement.

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Life insurance settlements and taxes

Another way to get access to life insurance benefits before you die to pay for your care is with what is called a life insurance settlement, known as a viatical settlement. There are companies that buy life insurance policies from people who are terminally ill for more than the cash surrender value but less than the face value.

The money you would get from a viatical settlement would be tax-free if you were certified by a doctor as terminally ill and expected to die in the next 24 months, Mullaney says. However, the third party that buys your policy will have to pay taxes on the payout it collects from the policy when you die.

Group life insurance and taxes

You probably receive some kind of life insurance coverage at work. If you have employer-provided life insurance, known as group life insurance, any coverage over $50,000 is treated as taxable income, but any amount under $50,000 is not taxed.

Group life insurance can be a nice addition to your benefits package, especially if it’s free or nearly free. But these policies can sometimes fall short if you have a growing family or your life insurance needs change throughout your career.

Use an online life insurance calculator to help you figure out your coverage needs.

Peace of mind and taxes

Every tax situation is different. If you’re worried about the taxability of your life insurance payout, you should consult with a tax professional.

If you are a Haven Life customer and have questions about whether your policy’s payout is taxable, the customer success team is available to answer your questions.

If you don’t have life insurance, consider the peace of mind that comes with financially protecting your loved ones in a way, that in most cases, is typically tax-free. Get your personalized life insurance policy rate.

Life insurance needs aren't one-size-fits-all.

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The information provided is not written or intended as specific tax or legal advice. Haven Life Insurance Agency does not provide tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.

Cameron Huddleston

About Cameron Huddleston

Cameron Huddleston is the author of Mom and Dad, We Need to Talk: How to Have Essential Conversations With Your Parents About Their Finances. She is an award-winning journalist with more than 18 years of experience writing about personal finance. Her work has appeared in Kiplinger’s Personal Finance, Business Insider, Chicago Tribune, Forbes, MSN, Yahoo and many more print and online publications. U.S. News & World Report named Cameron one of the top personal finance experts to follow on Twitter, and AOL Daily Finance named me one of the top 20 personal finance influencers to follow on Twitter. She has appeared on CNBC, MSNBC, CNN and “Fox & Friends” and has been a guest on ABC News Radio, Wall Street Journal Radio, NPR and more than 30 podcasts. Cameron has also been interviewed and quoted as an expert in The New York Times, Chicago Tribune, BBC.com, MarketWatch and more.

Read more by Cameron Huddleston

Our editorial policy

Haven Life is a customer-centric life insurance agency that’s backed and wholly owned by Massachusetts Mutual Life Insurance Company (MassMutual). We believe navigating decisions about life insurance, your personal finances and overall wellness can be refreshingly simple.

Our editorial policy

Haven Life is a customer centric life insurance agency that’s backed and wholly owned by Massachusetts Mutual Life Insurance Company (MassMutual). We believe navigating decisions about life insurance, your personal finances and overall wellness can be refreshingly simple.

Our content is created for educational purposes only. Haven Life does not endorse the companies, products, services or strategies discussed here, but we hope they can make your life a little less hard if they are a fit for your situation.

Haven Life is not authorized to give tax, legal or investment advice. This material is not intended to provide, and should not be relied on for tax, legal, or investment advice. Individuals are encouraged to seed advice from their own tax or legal counsel.

Our disclosures

Haven Term is a Term Life Insurance Policy (DTC and ICC17DTC in certain states, including NC) issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111-0001 and offered exclusively through Haven Life Insurance Agency, LLC. In NY, Haven Term is DTC-NY 1017. In CA, Haven Term is DTC-CA 042017. Haven Term Simplified is a Simplified Issue Term Life Insurance Policy (ICC19PCM-SI 0819 in certain states, including NC) issued by the C.M. Life Insurance Company, Enfield, CT 06082. Policy and rider form numbers and features may vary by state and may not be available in all states. Our Agency license number in California is OK71922 and in Arkansas 100139527.

MassMutual is rated by A.M. Best Company as A++ (Superior; Top category of 15). The rating is as of Aril 1, 2020 and is subject to change. MassMutual has received different ratings from other rating agencies.

Haven Life Plus (Plus) is the marketing name for the Plus rider, which is included as part of the Haven Term policy and offers access to additional services and benefits at no cost or at a discount. The rider is not available in every state and is subject to change at any time. Neither Haven Life nor MassMutual are responsible for the provision of the benefits and services made accessible under the Plus Rider, which are provided by third party vendors (partners). For more information about Haven Life Plus, please visit: https://havenlife.com/plus.html

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