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Reviewed by Benji Carr
Former Licensed Life Insurance Agent Benji Carr

UPDATED: Apr 21, 2022

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The Facts of Life

  • Life insurance premiums are classified as personal expenses
  • Personal expenditure is not tax-deductible
  • Few occasions allow insurance premiums to be tax-deductible

You clicked on this post because you’re interested in how life insurance is taxed. It seems strange for a post about life insurance to begin discussing taxes. 

But taxes are an important consideration before purchasing a life insurance policy, especially when the purpose is to reduce your taxable income. 

If you’re concerned about taxes and premiums, let’s plunge right in. 

Are premiums paid on personal life insurance policies deductible?

Life insurance premiums are not tax-deductible. However, if you pay your premiums through a life insurance plan provided by your employer, the money comes out of your paycheck pre-tax.

That’s because when you die, and the insurance company pays out to your beneficiaries, they don’t have to pay income taxes on the money. That’s why life insurance is often called death benefit — it’s like an inheritance that isn’t subject to the estate taxes that apply to larger inheritances.

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Why is life insurance not tax-deductible?

Because life insurance is designed to ensure your dependents are provided for upon your death, the IRS views life insurance as a personal expense. Therefore, in general, personal expenses are not tax-deductible. 

While life insurance is an important form of risk management for families and businesses, it’s not directly involved in producing income for either. Because of this, the government doesn’t consider life insurance a necessary expense and instead only allows deductibility in specific circumstances.

In the case of businesses, deductibility is allowed when the policyholder (the employer) buys the policy on a key employee – whose death would have a significant financial impact on the company. This type of life insurance is known as key person insurance or key man insurance and is tax-deductible because it protects against economic loss.

Tax Benefits of Life Insurance

While it may seem counter-intuitive, the IRS actually provides a few distinct income tax benefits for life insurance. These benefits are available when you own your policy or have an interest in certain policies.

Tax-free Death Benefit

This means that any death proceeds paid out to a beneficiary are not considered taxable income for that person. This benefit also applies to cash-value withdrawals and loans from a permanent policy by the policy owner.

This is the major difference between life insurance and investments like stocks and bonds. The sale of these investments is considered taxable income. So you will be taxed if you sell your stocks or bonds at a profit. But if you sell your life insurance contract or withdraw cash value from it, you’re not taxed.

Building Cash Value on a Tax-Deferred Basis

The cash value of your life insurance policy accumulates tax-deferred — that is, you don’t pay taxes on the cash value until it is withdrawn. This means more money working for you while it is in the policy, and there are no limits on how much can be contributed to the policy each year.

Paying for Premium Costs with After-Tax Dollars

You can make premium payments from taxable or nontaxable income sources. If you’re in a high-income tax bracket, this may be beneficial to you. You can even deduct those premiums from your taxable income if you meet specific requirements (such as using the policy for business purposes).

Tax-Free Loans

You can borrow from the cash value of your permanent life insurance policy. This can be a very low-cost way to get a loan. 

Loans from a life insurance policy do not incur income taxes, and there is no limit on the amount you can borrow as long as your cash value remains high enough to sustain the loan. 

Though some policies require you to make premium payments while your policy has a loan against it, others allow you to stop making those premium payments if your cash value is high enough to cover the cost of insurance.

Circumstances for Insurance Premium Taxation 

Any time you purchase an insurance policy, there is a chance that the premium could be taxed. But, of course, not all companies charge a tax on insurance products, but those that do follow a set of rules and regulations. And they generally apply to policies with a cash value. 

These are as follows:

  • Surrendering your life insurance. If you give up a permanent policy in exchange for cash, you will get some of the cash value funds in return. If you receive a refund that is greater than the amount you placed into the account (the principal), the excess is subject to taxation.
  • Selling your life insurance. If you don’t need your life insurance policy anymore, it’s legally allowed to surrender it. Profits from the sale are subject to income taxation.
  • The death benefit is paid out in installments. If your beneficiaries choose to receive benefit payments in the form of an annuity, they may be subject to taxation. In addition, it is possible that the unpaid money will earn interest, and such interest is subject to taxation.
  • Withdrawing money from your insurance policy’s cash value. Similar to investment accounts, cash values accrue interest that is tax-deferred. However,  if you withdraw from your cash value, any sum above the principal of your account will be subject to taxation.
  • Premiums payable to an uninsured person. Premiums paid by an individual or company on life insurance policies are not taxable if they are payable to the insured person. However, premiums are taxable if they are payable to someone other than the insured person. This includes policies issued on the life of a spouse or child.
  • If proceeds are used to fund charity. In some cases, an insurance policy is meant to fund a charitable gift, such as donating to a charity when you die. Therefore, that part of the premium may be considered a charitable donation and thus tax-deductible. However, keep in mind that there are limits on how much you can deduct in charitable donations per year.
  • If It’s a business expense. When a business pays the life insurance premiums, they are deducted as business expenses on your taxes. As a result, such expenses are subjected to tax as business overheads. 

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Benefits of Paying Taxes on Life Insurances Premiums

Paying taxes on life insurance premiums can be confusing for many people. While it is not exactly a taxing process, there are some important benefits you need to be aware of before you begin paying these taxes.

The first benefit of paying taxes on life insurance premiums is that you will deduct the amount from your income tax return if you itemize deductions on Schedule A (Form 1040). This means that any money paid out of pocket for life insurance premiums will be deducted from your taxable income, which can help lower your overall tax burden.

You may also deduct the cost of a policy or contract when you make changes to it or replace it with another policy. For example, if you get divorced, and your ex-spouse is no longer responsible for paying the premium, then you would deduct the cost of the new policy from your taxable income.

The second benefit of paying taxes on life insurance premiums is that they are considered an expense in calculating how much you owe in federal income tax. This means that if your total income exceeds the standard deduction in the year you die, then those expenses will reduce your taxable income and lower the amount owed to Uncle Sam.

Should you consider tax on premiums only when buying life insurance?

No, you should not only think about tax benefits while buying a life insurance policy. 

While considering a life insurance plan, you should look at the premium amount and the returns provided by the policy. With regular premium plans like term insurance plans and endowment plans, you can get improved coverage at an affordable cost.

You must also look at the claim settlement ratio of an insurer before buying a policy from them. This will help you understand how likely they will settle claims during their financial year. Finally, you must look at the benefits of a particular type of policy before investing in one.

Time to Decide

Therefore, life insurance is considered a personal expense and therefore not tax-deductible. However, you need to consult with the company’s representative to determine the final state of your policy– due to some exceptions to this policy. Then, if you are ready, shop around for quotes and make an informed coverage decision.