Jeffrey Johnson is a legal writer with a focus on personal injury. He has worked on personal injury and sovereign immunity litigation in addition to experience in family, estate, and criminal law. He earned a J.D. from the University of Baltimore and has worked in legal offices and non-profits in Maryland, Texas, and North Carolina. He has also earned an MFA in screenwriting from Chapman Univer...

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Written by Jeffrey Johnson
Insurance Lawyer Jeffrey Johnson

Benjamin Carr was a licensed insurance agent in Georgia and has two years' experience in life, health, property and casualty coverage. He has worked with State Farm and other risk management firms. He is also a strategic writer and editor with a background in branding, marketing, and quality assurance. He has been in military newsrooms — literally on the frontline of journalism.

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Reviewed by Benji Carr
Former Licensed Life Insurance Agent Benji Carr

UPDATED: Jun 6, 2022

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The Facts of Life

  • Most death benefits from life insurance aren’t taxable
  • Earned interest on some life insurance benefits are taxable
  • Discuss how your life insurance can be taxed before you start the policy

Is life insurance taxable? While death benefits generally won’t be taxable, there are still some instances when your beneficiaries may have to pay income tax on your life insurance proceeds. Advanced planning and understanding your policy’s terms can keep your beneficiary from paying too much in taxes.

Curious about rates for when life insurance to avoid taxes? Enter your ZIP code into our free quote tool to see what you could pay today.

Are life insurance proceeds taxable?

Is life insurance taxed? In most cases, the answer is no. Life insurance death benefits are generally paid to the beneficiary tax-free. However, there are still instances when you’ll run into taxable life insurance benefits.

According to the Internal Revenue Service, death benefits associated with a life insurance policy aren’t taxable in almost all instances. However, your beneficiary may have to pay taxes on any interest accrued on that money. This happens when the life insurance company holds the money (by agreement with the policyholder ahead of time) for a while before paying it out.

Do you have to pay taxes on life insurance?

Do you pay tax on life insurance? In most cases, untaxable proceeds from life insurance are passed to the beneficiary without any issues. However, as mentioned above, there are a few instances when taxes will be owed on life insurance.

You’ll have to pay for taxes on life insurance proceeds in a few specific situations. Some cases where you get the money from the insurers are taxable, including:

  • Earned interest
  • Estate and inherited taxes
  • Cash value

While the specifics vary in these examples, you will owe taxes at some point when any of these apply. However, most of these can be avoided. 

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When do you have to pay taxes on life insurance?

As previously mentioned, some examples of taxable life insurance proceeds include cash value, interest, and estate taxes. Except the tax on a cash value account, careful planning can ensure that you avoid these taxes.

While these are just a few examples, talk with your insurer and financial planner before starting the policy to discuss how your life insurance will affect your taxes.

How does cash value impact life insurance taxes?

Cash value is one of the best whole life insurance benefits, as it saves a portion of your premiums into a savings account each time you pay.

Cash value has a tax-deferred status, allowing you to earn more in the savings account while the policy is in effect. However, the cash value isn’t free from getting taxed, just delayed. For example, you’ll be taxed when you withdraw an amount or give the cash value to your beneficiary. Beneficiaries in these circumstances should talk with a financial planner or tax professional to minimize the amount of tax they may pay.

What is interest income on life insurance?

According to the IRS, any interest received on your policy is likely taxable, even if the death benefit is not. For instance, if your insurance company informs you of any savings accounts that grow, your cash value or death benefit over time will be taxable.

If the insurance company holds onto the payout before it goes to the beneficiary, you will be taxed on any interest earned. Make sure your payout is immediate to avoid these taxes.

What are estate and inherited taxes?

An estate tax is what your beneficiaries will pay when they transfer ownership of the property after you die. The property will be assessed as of the owner’s date of death. Assets that are part of an estate include:

  • Cash
  • Real estate
  • Business interests
  • Personal property

If the ownership of something is being transferred from your name to another party, you’ll likely have to pay the taxes for its estimated value before you can claim ownership.

In most cases, life insurance benefits are not considered a part of the estate, since the proceeds go directly to the beneficiary of the life insurance company. They will only become part of the estate if the estate is named as the beneficiary in the policy.

How can I avoid taxable income on life insurance?

If you’re looking to avoid the taxes on your estate, there is a way that you can achieve this. While it won’t protect you entirely from taxes, you can still save your beneficiaries a fair amount of money by planning ahead.

First, be careful about how you name your beneficiary. Make sure the proceeds don’t go to the estate or sit in probate by making sure you have both a primary and contingent beneficiary named. If something happens to the primary, your contingent beneficiary will get the death benefit rather than it being made a part of your estate.

How can I use a life insurance trust to avoid taxes?

To avoid paying taxes on any life insurance benefits yourself, you can also create an irrevocable life insurance trust. When you sign up for the ILIT, you guarantee that:

  • You no longer have rights to the policy
  • The owner is someone you approve
  • The policy is no longer a part of your estate

If you execute this type of trust correctly, you can avoid estate taxes by removing the money from your estate. These are just a couple of the potential tax benefits of an ILIT. Discuss with your insurer or consult a financial planner to be sure, and bear in mind that it’s called irrevocable for a reason. Once it’s in place, you can’t change it.

Taxable Life Insurance: The Bottom Line

While the death benefit on most life insurance policies isn’t taxable, that’s not universally true. Other life insurance proceeds like interest and cash value will be subject to paying income taxes. Therefore, it’s wise to discuss any gift taxes on your policy with your insurance agent before you purchase it.

Speak to a licensed financial advisor about the tax implications of your life insurance policy.