One of the most appealing aspects of life insurance is that the payout is tax-free to your beneficiaries. It’s a huge advantage to acquire (and receive) life insurance because death payouts can be in the millions of dollars. However, there are several components of life insurance that will not be taxed.

When is a life insurance payout not taxable?

Individual beneficiaries are generally exempt from federal income tax on life insurance payouts. This is because life insurance payouts are not included in your gross income and are not required to be reported to the IRS.

Consider the following scenario: You are the beneficiary on someone else’s insurance, such as a parent’s or spouse’s, and you get a payout from the policy when the insured person dies.

You won’t have to pay federal income tax on the dividend because you’re the listed recipient.

If you’re the policyholder, have a terminal disease, and are getting accelerated death benefits (payments made while you’re still alive), such benefits are typically not taxed as well.

When is a payout taxable?

  • You Withdraw Money from Cash Value: Cash-value withdrawals are not always tax-free. If, for example, you take a withdrawal during the first 15 years of the policy—and the withdrawal causes a reduction in the policy’s death benefit—some or all of the withdrawn cash could be subject to taxation.
  • You Surrender the Policy: A policy owner may decide that they no longer want or need their life insurance coverage. You can take the policy’s surrender value and the insurer will cancel the coverage. Your cash value less any surrender charges is the amount you receive. A policyholder may decide that their life insurance coverage is no longer needed or wanted. You can take the surrender value of the insurance and the insurer will cancel your coverage. The amount you get is the cash value less any surrender costs.
  • You Took Out a Policy Loan and the Life Insurance Ends: Although this is not a taxable problem, it nevertheless has an impact on the beneficiary. In a cash value insurance, the policy owner can borrow against the money. If you take out a loan on your policy and don’t pay it back, the insurance company will remove the amount you owe from the death benefit before paying it out.
  • You Sell the Life Insurance Policy: Existing life insurance plans, particularly cash value life insurance policies for those who are terminally sick or have short life expectancies, have a market. The term “viatical settlements” refers to transactions involving terminally sick policyholders. These include an investor, such as a business that specializes in purchasing policies, paying you money for the policy, becoming the policy owner, and then filing a life insurance claim after you die.
  • You Are Life Insurance Beneficiary Who Receives Interest on a Death Benefit: The majority of life insurance payouts are given in one lump amount shortly after the insured person’s death. However, some beneficiaries want to postpone the payout or receive it in increments over time. The interest from the life insurer may be taxed if the delayed payouts include it.
  • The Life Insurance Payout Goes Into a Taxable Estate: A life insurance payout may go to the insured individual’s estate rather than a specified beneficiary in specific situations. Your life insurance payment may be liable to estate taxes if it becomes part of an estate. Only individuals with a vast estate are affected. It’s possible that your life insurance payment may be taxed if it goes to an estate worth more than $10 million.

Have additional questions about your life insurance, please feel free to contact Panichelle Insurance at https://panichelleinsurance.com/contact-us/

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