Life insurance policies are kind of unique if you think about it. It’s an insurance policy where the person who buys the policy is not the beneficiary. Rather it’s usually their spouse or other family members who are.
A life insurance policy creates a contract in which the policyholder will pay premiums until his/her time of death or after the contract has expired. Once the policyholder passes away, the insurer will pay the death benefit associated with the policy to the named/chosen beneficiaries.
Is Life Insurance Taxable?
However, many people still wonder if life insurance is taxable. Well is it? That is what we are here to answer.
Most of the time, life insurance is not taxable. According to the Internal Revenue Service (IRS), you do not have to report the amount of money you have received as income when you are filing taxes. Because life insurance death benefit is a possible lifeline for families, both federal and state tax law does not tax life insurance benefits.
When It Might Be Taxable
However, in some cases, life insurance death benefits may be taxable. However, cases like those are only rare. Here we discuss when does life insurance death benefits become taxable.
Most of the time, beneficiaries claim life insurance death benefit payouts by way of a lump-sum payment. This means that the beneficiary receives all of the policyholder’s investments from the insurer. Receiving a life insurance death benefit by the method of lump-sum payment is not taxable.
Another way a beneficiary can receive the policyholder’s life insurance death benefits is through the way of installments. This means that the beneficiary will receive portions of the benefits from time to time rather than in just one go.
This type of claim is taxable. Each payment in an installation has interest, and the interest earned on the death benefit is taxable.
The beneficiary should receive a Form 1099-INT from the life insurance company. This document will inform the beneficiary that the interests in their benefits are taxable. If the beneficiary is also a high-income earner, he/she may have an additional tax on the interest that he/she will receive.
Another way a life insurance death benefit may become taxable is if the beneficiary is an estate. This is where it gets more complicated. If the life insurance death benefit exceeds the value of $11,580,000, the beneficiary is obliged to file an estate tax return. The estate increases in value if the policyholder includes proceeds, which in return could lead to higher estate taxes for beneficiaries. The proceeds added to the estate may be taxable and in some cases, it is taxable in both federal and state.
How To Spend Life Insurance Proceeds
What should the beneficiary do with the life insurance proceeds? To answer that, the beneficiary can choose to spend it the way he/she wants it or to not at all. However, we got a couple of suggestions that may help the beneficiary.
One of which is to pay off some debt using that money if they have any.
Another great way to use that money is to save it for emergencies. Say a disaster or a pandemic has occurred, or when one of your family members got hospitalized. You can use these benefits to help pay hospital bills or purchase what you need in times of crisis.
If you don’t need all the money, you can also donate some to a charity in honor of the policyholder who passed away.
Of course, you’re totally okay to take a nice trip or splurge a bit on yourself some other way! Just be sure you don’t need the money you spend on that stuff.