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In most cases, the recipient of a life insurance death benefit does not have to pay any income taxes on the amount received. They must, however, include in their gross taxable income any amount received that is over the amount of the life insurance death benefit that was payable at the time of the insured party`s passing. An example: if the life insurance death benefit is $100,000 and the beneficiary received $100,200, the $200 is taxable interest and must be included as such on their tax return.
If the amount of a life insurance death benefit paid out is not any more than the amount of the life insurance death benefit that was payable at death, it is not taxable. An example: the life insurance death benefit is $100,000 and the beneficiary receives $100,000. That means there is no taxable interest that must be included on the beneficiary`s income tax return.
Should an individual be the recipient of a life insurance death benefit that comes in installments, they are able to exclude a portion of each death benefit installment payment from their overall taxable income amount on their annual tax return. To calculate how much, the life entire insurance death benefit policy amount should be divided by the total number of years payments will be received. The resulting figure is the amount that can go untaxed each year.
Basic estate planning often includes life insurance. Because generally taxes are not owed on life insurance death benefits, they can provide beneficiaries a sum of money far in excess of the premiums paid that is income tax free. That is, however, entirely dependent upon the proper structuring of beneficiary and ownership designations.
There are in existence federal and state estate taxes that may come into play upon the death of the insured that will result in a tax being imposed upon any property that the person owned, which is payable by the estate. This tax may not be an issue if the property is worth less than the value of the amount of the estate tax exemption. Should the deceased own a life insurance policy that lists either themselves or the estate as a beneficiary, that payment amount will boost the overall value of the estate. If after factoring into the value of the estate the proceeds from a life insurance death benefit the estate remains at a value that is less than the amount of the tax exemption, no federal tax will be issued. Thus, the death benefit proceeds yielded from a life insurance policy can be passed along to any heirs and not need to be put towards the payment of any federal estate tax liability.
However, if the property owned by the deceased exceeds the amount of the estate tax exemption and she or her estate was listed as the beneficiary on their life insurance policy, the death benefit proceeds of that policy may very well be eligible for federal estate taxes.
For people who are concerned about estate taxes, it is better if their life insurance policy is owned by someone else who has been established as the owner and beneficiary of the policy via an irrevocable trust. Another option is to designate any adult children as beneficiaries and owners of the policy.
Any gift of life insurance bequeathed upon a third party who is not a spouse can potentially carry tax consequences. Another possible pitfall is if the individual covered by life insurance fails to survive the gift by three years the policy may be returned to the estate. These complications are why it`s wise to seek out legal and tax advice before deciding to make any transfers of life insurance policies.