How are Life Insurance Payouts Taxed, if at All?
Raising a family can be a rewarding experience, but just like most life issues, it comes with “what ifs.” What if you die? What happens to your family without your income?
Because of this possibility, many people get life insurance. Life insurance offers a payout to your beneficiaries in the event of your death. You make monthly premiums based on the amount of life insurance you choose.
Life insurance is a good option to replace your income because it is primarily nontaxable. If you receive the money after a loved one’s death, and it is in a lump sum, then you should receive the full amount. Life insurance proceeds are not included in gross income, and you do not have to report them to the IRS.
But of course, there are always exceptions. There are several types of life insurance as well as various ways of receiving payouts. This means that your life insurance proceeds could be taxed in some cases.
When Could Life Insurance Be Taxed?
- When the policy becomes part of the estate. If a policy does not name a beneficiary, the proceeds may be included in the deceased person’s estate. If the total estate value exceeds the federal estate tax exemption ($15 million for 2026), then estate taxes may apply to the amount above that threshold. In addition, some states impose their own estate or inheritance taxes (Michigan does not impose either).
- When the death benefit is paid as an annuity. If a beneficiary elects to receive the death benefit in installments rather than a lump sum, any interest earned on those payments is generally taxable. The original death benefit remains tax-free, but the interest portion is treated as income.
- When you withdraw from or borrow against a whole life policy. Whole life insurance builds cash value over time. You may withdraw funds or take out a loan against that cash value. Withdrawals that exceed the total premiums you have paid into the policy may be subject to income taxes.
- When you surrender a whole life policy. Surrendering a policy means canceling it in exchange for its cash value, which may be reduced by surrender charges. If the amount you receive exceeds the total premiums you paid, the excess may be taxable as income. If the surrender value is less than what you paid in premiums, you typically will not owe income taxes.
- When you sell your life insurance policy. If you sell your policy to a third party, taxes may apply to any amount you receive above your adjusted cost basis, which is generally your total premiums paid minus the cost of insurance. That excess may be subject to income taxes.
Contact Us Today
Life insurance is a good option to ensure your family is cared for financially in the event of your death. Plus, there are typically no taxes involved, making things easier for your beneficiaries.
A Saline, MI, agent from Hartman Insurance Agency, Inc. can help you find the life insurance policy that meets your needs. We will work to protect you and our family when life brings about challenges. Schedule a consultation today to learn more. Contact us via (734) 999-4190 or online here.