Losing a loved one is devastating. Life insurance can ease the sting by making sure financial troubles don’t pile on top of grief. But if the policy’s payout creates an unexpected tax bill, your planning may be less effective than you intended.
Here’s what to expect if you ever receive a policy payout, and what to know if you’re planning to protect your own loved ones with life insurance.
Interest on Unpaid Death Benefits
Instead of receiving a lump sum, life insurance beneficiaries can receive their payout gradually. The portion of the death benefit that hasn’t yet been paid out earns interest. Like savings account interest, it is typically taxable income.
Surrendered Policies
If you have a permanent life insurance policy that you no longer want, you may be able to get back your policy’s cash value minus any surrender fees. If you get back more than you paid in premiums, the difference may be taxable.
Policy Loans and Withdrawals
Funding cash value life insurance with large premiums up front means the IRS may consider the policy a modified endowment contract. In that case, loans and withdrawals may be taxable.
Estate Taxes
In 2024, the estate tax exemption is at an all-time high of $13.61 million ($27.22 million for married couples). If your wealth meets that threshold or your state has a lower exemption, taxes could reduce your beneficiaries’ payout. Life insurance counts as part of your estate unless you place it in a life insurance trust.
We can help you understand your policy’s tax implications, or explore coverage options if you aren’t insured. Let us know how we can help.