Is Life Insurance Taxable?
There are many different types of life insurance policies available to provide your
loved ones with financial assistance after you have died or become terminally ill. Most companies will readily provide you with life insurance policies that appear to suit your goals, yet the question of tax is an important consideration that can be overlooked in the process. You may be surprised how many additional taxes you and your beneficiaries have to pay because of your life insurance policy.Here we will consider three main life insurance tax questions that people commonly ask.
Are you required to pay tax on life insurance interest?
Yes. Life insurance interest that you can readily withdraw from your account is generally considered taxable and needs to be reported in your taxes.
Do you need to pay tax on life insurance policy dividends?
No. Life insurance policy dividends are not taxable because, unlike the interest of your life insurance investment, they are considered to be the return on your initial premium payments. You may be required to pay tax on the interest of those dividends, rather than the dividends themselves, during the year in which the funds are readily available for you to withdraw. Some life insurance policies have special exemptions and do not require you to pay tax on the interest from dividends; for example, Veterans life insurance policies are tax free in this regard. If you buy common stocks of a life insurance company however, those dividends are taxable because they are governed by the same laws as any other stocks on the market.
When the dividends of your life insurance policy exceed the premiums that you previously paid, they can become taxable.
Will my beneficiaries have to pay tax on their inheritance benefits?
It's important that you consult the tax laws of the state you reside in, as each state has slightly different laws about inheritance taxes. Often those holding a life insurance policy on his or her own name will be subject to a federal estate tax, and some states have additional state estate taxes on these policies as well. If the estate is named as the beneficiary on your life insurance policy, or if the policy can be considered a part of your gross estate, the death benefits become taxable. Life insurance proceeds are often considered tax free when paid directly to your beneficiary, but that does not stop the proceeds from being counted as part of your estate if you held ownership of the policy at the time of death. Life insurance quotes can seem like great offers until these additional taxes are taken into consideration. To avoid these taxes, some people open life insurance trusts and list their children as the owners.
Be sure to ask your life insurance company or financial advisor for further clarifications on these topics, as tax laws on life insurance are always subject to change. Asking about tax costs when studying life insurance quotes will give you a much clearer picture of the real value that your policy will provide.
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