Many people wonder if the proceeds of a life insurance policy are taxable to the beneficiary. The short answer is that most of the time, the policy payout (called a death benefit) is not taxable to your beneficiary. That’s part of the draw of life insurance: a tax-free financial safety net for your loved ones.
There are some scenarios when a life insurance payout can be taxable Here, understand what scenarios might make a term life insurance policy taxable.
Is a term life insurance payout taxable?
Term life insurance payouts may, however, have tax implications in three main instances: interest on death benefits, utilizing the accelerated death benefit rider, and estate tax triggers.
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Taxation of death claim payouts
When a policyholder dies, assuming it’s a legitimate death and claim, the life insurance company is usually required to pay simple interest from the date of passing to the date the claim is paid. That interest, in turn, represents a taxable event, and the beneficiary would be issued a Form 1099-INT by the insurance company. If this occurs, the beneficiary of a policy would need to report the earned interest on his or her tax return.
While that may seem like a pain, it’s actually a good thing. This rule is in place to help ensure that the proceeds of a life insurance policy are paid to beneficiaries in a timely manner. It is important to note that typically, you are not required to pay taxes on the death benefit itself, but only the interest.
Accelerated death benefit taxation
Another instance in which a term life insurance policy payout might be taxed is if you exercise the accelerated death benefit rider. This type of life insurance rider can usually be added to a policy at an additional cost or it may be an inherent benefit of the policy. With Haven Life, this rider is included in the price of each Haven Term policy. The way it works is that when a policyholder is deemed to be terminally ill, he or she can access a portion of the policy’s benefits prior to death, which can be valuable to help get affairs in order. It is important to know, however, that if the accelerated death benefit is exercised, the policyholder will be issued a Form 1099 LTC, which could result in taxation.
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Estate taxes and life insurance
Another instance in which term life insurance could be taxable is if the proceeds are left to your estate instead of being directly released to your beneficiary. Currently, the estate tax applies when your estate is valued at more than $11 million. Not surprisingly, there are numerous tax strategies surrounding estate tax (including transferring your policy to an irrevocable trust which can help avoid the estate tax on policy proceeds), so make sure to consult your tax advisor with questions.
There are a few of the scenarios where term life insurance may be taxable to policyholders. For Haven Term policyholders who have questions about their policies, our customer support team is available.
Rachel Parisi is a freelance writer and attorney. She focuses her writing on insurance, financial services, and employee benefits. In her previous life, she served in the United States Air Force as a missile combat crew commander (think ‘Wargames’).
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.