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Life insurance payouts are meant to be life-changing—large enough to cover end-of-life expenses or to help support a surviving spouse and children. Life insurance payouts generally aren’t taxable, though there are a few exceptions.
Whether you’re buying a policy or expect to be the beneficiary of one, read on for some quick guidance on the tax rules surrounding payouts, cash value withdrawals, group life insurance and whether you can deduct life insurance premiums on your taxes.
Are Life Insurance Payouts Taxable?
Life insurance payouts are generally tax-free. If someone has made you the beneficiary of a $1 million policy, for example, you do not have to share any part of your $1 million with the federal government. There are, however, a few cases where taxes may apply.
If your life insurance payout includes interest earned after the time of death but before the time of the payout, that interest is taxable as income. Let’s say it takes you a few months to submit insurance paperwork, and in those few months your $1 million payout earns $1,000 in interest. You must report that $1,000 on your taxes. This may also apply if you receive a payout in installments: The interest earned on principal is taxable.
If the overall estate exceeds federal limits, a life insurance payout could affect your inheritance amount. As of 2022, estates with a total value of $12.06 million or less are free from federal estate taxes. If a life insurance payout is part of an estate that is worth more than $12.06 million, the estate will be taxed—which could affect the net size of your inheritance. Some states also levy estate taxes, and state limits may be significantly lower than federal limits.
Current estate tax limits are set to expire in 2026, when they may drop to $5.6 million. If you own, are about to purchase or expect to be the beneficiary of life insurance that is part of a large estate, you may want to consult with a tax professional or estate planning attorney to fully anticipate what these changes might mean for you.
Are Cash Value Withdrawals Taxable?
Life insurance policies fall into two main categories: term policies that pay a benefit upon death within a set period of time (usually 10, 20 or 30 years) and permanent life policies that pay a death benefit and may accrue cash value as well. If you have a permanent life policy—whole life, universal life or variable universal life—with an available cash value or face value, you can typically withdraw at least some of the cash without incurring income tax.
Here’s the catch: Cash withdrawals from your policy could be taxable—or partially taxable—if your withdrawal exceeds the amount you’ve paid in premiums. Suppose you’ve paid $10,000 in premiums over the years and, with interest and dividends, your policy now has a cash value of $14,000. If you withdraw $11,000 from the cash value of your policy, you will pay income tax on $1,000, the amount you’ve withdrawn that exceeds your total premium payments.
Withdrawing cash from your life insurance policy can have repercussions, both to your taxes and to your policy. Study up on your options before you make this move to avoid any unwanted consequences.
Is Group Life Insurance Taxable?
Do your employee benefits include a term life insurance policy (also known as a group plan)? For the first $50,000 of coverage, the IRS excludes the group life insurance premiums your employer pays on your behalf. As long as your coverage doesn’t exceed $50,000, your premiums are not included in your taxable income and are therefore tax-free.
What if your employer provides more than $50,000 in coverage? Your employer will add the cost of the extra coverage to your reported wages, where it is subject to income tax and Social Security and Medicare taxes. Also note: The tax on excess coverage isn’t based on what your employer pays but instead on how much the IRS determines you owe. That said, this cost may be minor, especially if you’re under age 65. An additional $50,000 of coverage will add only $33 in taxed income per month if you’re age 60 to 64 and only $3 if you’re age 25 to 29. Don’t want the additional coverage—or the taxable income? Ask your employer if they can reduce your coverage to $50,000.
Is Life Insurance Tax Deductible?
If you purchase your own life insurance policy, your premiums are not tax deductible. The IRS considers life insurance premiums to be a personal expense.
Life insurance premiums may be deductible as a business expense if you own a business and you offer group life insurance as an employee benefit, but neither you nor your business can be the beneficiary of the life insurance coverage you provide. Additional IRS guidelines may apply here, so consult a tax professional if you’re interested in pursuing this business deduction.
The Bottom Line
Although life insurance premiums are not deductible, the overall financial benefits of life insurance can be substantial, including the ability to maximize the money you pass along to heirs or to charity. Learn more about the different types of life insurance and how to choose coverage that works best for you on Experian’s blog.