Life insurance provides financial resources to your family or designated beneficiaries after you pass away. Coverage is provided in the form of whole life policies that do not expire and term life insurance that is designed to cover a designated period of your life such as ten years. A variety of specialized insurance products provide savings mechanisms, potential dividends and earnings potential. The taxable factors of life insurance depend on the type and distribution of life insurance proceeds, employer contributions and the reason for distributions.
Beneficiaries
If you are the beneficiary of a life insurance policy, you generally do not have to pay taxes on the death benefit received. This non-taxable status applies to all types of life insurance coverage including accidental death and dismemberment policies. Any interest or accrued earnings that occur between the policy renewal the policyholder's death above $1,000 that you receive directly are subject to taxation and must be included as interest income earnings on your tax filings.
Payment Method
Tax exemptions for death benefits are primarily designed for lump-sum payouts. For life insurance policies that provide installment payouts, you can exclude the amount of each payment that equates to the lump-sum value and pay taxes only on the payouts above the lump-sum threshold. This value can be established on installment for life policies by dividing the policy value by your life expectancy. For standard installation plans, divide the policy value by the number of installments.
Split-Dollar Life Insurance
The premium payments made on split-dollar life insurance policies by your employer are subject to taxation if your employer owns the policy. If you own the life insurance policy, employer payments are treated as an employee loan and you must pay the difference in the interest rate your employer is charging and the prevailing market loan rate.
Payments And Payouts
Interest payments from a life insurance policy are subject to general income tax in the year the interest is received. If you receive accelerated death benefits due to a chronic or terminal illness, all funds are excluded from taxes. Some disbursements may require documentation of a medical illness to qualify for a tax-exempt status.
Sold Or Surrendered Policies
If you sell your life insurance policy, or surrender it for cash, any value above your policy cost must be treated as income on your taxes. Your policy cost includes all premium payments minus any proceeds you received such as dividends or rebates.
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