Is life insurance taxable?

Last updated: January 1

The Internal Revenue Service (IRS) says benefits paid out from a life insurance policy are generally not subject to federal income taxes, provided they are received as a result of the insured person passing away. In that case, your beneficiaries would not have to report the amount or include it as gross income on federal tax returns.

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However, any interest that beneficiaries receive in addition to the policy amount is considered taxable and should be reported to the IRS. If your beneficiaries receive the proceeds in installments that include interest payments, the amount of interest included in the payment is typically considered taxable income, says the IRS.gov. For example, if your beneficiaries receive a total of $101,000 for a $100,000 life insurance policy, the $1,000 is taxable at their income rate.

State tax rules vary from state to state. A tax advisor or your state's tax agency can provide information on what benefits, if any, are taxable in your state.

Is a partial withdrawal from life insurance taxable?

If you have a life insurance policy with cash value or accelerated death benefits, you may be able to make a partial withdrawal of your policy's funds without incurring a federal income tax liability.

Cash value loans

If you have a permanent life insurance policy, you may be able to borrow against the cash value that has accumulated on your policy1. According to Forbes, these loans, as allowed by your policy, are typically not taxable to you. Keep in mind that any money you borrow, plus interest, may be deducted from the policy's death benefit that's paid out when you pass away.

Accelerated death benefits

If you opted up front for accelerated death benefits, your life insurance policy's proceeds may be available to you should you become terminally or chronically ill. Accelerated death benefit payments, in which you receive some of your own policy's proceeds, are typically tax exempt, according to Investopedia. Limitations and exceptions may apply, so be sure to talk to your agent about what may be available with your specific policy.

Your beneficiaries would receive the remaining amount of your policy benefits when you pass away, which would also typically not be taxable.

Life insurance benefits are generally not federally taxable, but each policy is different and each state's tax rules may vary. It's a good idea to consult with your agent or financial advisor if you have any questions about your life insurance policy.