• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar

Wealth Pilgrim

No Money Worries. No Matter What.

Neal Frankle featured in
  • Home
  • Life Insurance
  • Investing
    • Build Strong Investment Building Blocks To Avoid Going Broke In Retirement
    • Systematic Mutual Fund and ETF Investing
    • Stock Market Investing Guide
    • Choosing the Right Investment Brokerage Guide
    • How Bonds Work Guide
    • How Banks Really Work Guide
    • Annuities – What You Need To Know Before You Invest
    • A Beginners Guide To Buying Individual Stocks
    • Create A Pool Of Great Mutual Funds and ETFs To Pick From To Secure Your Retirement
    • ETF and Index Fund Investment Guide
  • Earn More
  • Banking
  • Retirement Planning
    • Retirement Guide
  • Ask Neal a Question
  • Reviews
    • Upgrade Personal Loans Review
    • Lending Club Review
    • Prosper Review
    • Ally Invest TradeKing Review
    • CIT Bank Review
    • LegalZoom Review
    • Lexington Law Review
    • Airbnb Host Review
    • Should You Drive For Uber?
  • Tax
  • Courses
    • Raise Your Credit Score So You Can Buy a House – Free Video Course

Are Life Insurance Death Benefits Taxable?

by Neal Frankle, CFP ®, The article represents the author's opinion. This post may contain affiliate links. Please read our disclosure for more info.

No they are not – if you take a few simple precautions.  In fact, it’s very easy to avoid paying income tax on life insurance proceeds. Then again, all it takes is a little sloppy bookkeeping and you can inadvertently name Uncle Sam your new life insurance beneficiary. Who needs that? Let’s make sure that doesn’t happen.

The Rules

When you buy life insurance there are three parties involved; the owner, the beneficiary and the person who is insured. Typically the person who buys the insurance is the owner and the insured. If I buy life insurance on myself I own it and I am probably the insured. As the owner I get to name the beneficiaries. Simple as that.
I can name anyone I want as the beneficiary. If I die, the beneficiaries will get the loot and they won’t pay a cent in income or estate tax. Sweet (for them). The are really only a few exceptions to this.

The Exceptions

If I name my estate or my living trust as beneficiaries or if I fail to name a beneficiary, the proceeds will be included in my estate and therefore taxable. Why? Because according to the IRS I have an “incidence of ownership” in those situations. That’s bad news because my estate may have to pay estate tax on those proceeds.

But the good news is that this is completely avoidable. All you have to do is make sure to name someone else as the beneficiary. Since the entire reason you buy life insurance to provide for others, this isn’t a hard requirement to comply with.

The second exception is if you buy life insurance through your employer using pre-tax dollars. If you go this route and then die, the death benefit becomes taxable income.
Your beneficiaries won’t have to pay it per se but the income tax is going to going to take a huge slice out of that pot of dough and there will be a lot less available for the family as a result.

Many employers offer life insurance group policies and they are usually a fantastic benefit. Just make sure to check with HR. If you have the option, think about buying that life insurance with after-tax dollars instead. That way, if you pass away, your family will get 100% of the benefit and beat the tax man at his own game.

There is one other reason why your beneficiaries might pay some tax on death benefits and that’s when the money earns interest before being distributed to the beneficiaries.

Let me explain.

Once there is a death claim and the paperwork is settled, the benefit becomes available immediately. Sometimes the beneficiaries leave the money on deposit with the insurance company until they decide what to do with the money. In that case, the insurance company pays interest and that interest is taxable.  This isn’t a huge problem and it’s not something you should worry about but it’s something to be aware of.

As you can see, it’s easy to shield life insurance death benefits from the tax man. Make sure you have the right beneficiaries that you have no incidence of ownership and that employer-provided life insurance is paid for after-tax. Of course there are always exceptions. Depending on your particular situation, you may want to use other tactics. That’s when a good qualified estate planning attorney really comes in handy.

Have you considered how to structure your life insurance to minimize tax? What have you done? What are your major concerns?

Tweet
Pin
Share9

Reader Interactions

User Generated Content (UGC) Disclosure: Please note that the opinions of the commenters are not necessarily the opinions of this site.

Comments

  1. Shibu Thomson says

    April 2, 2017 at 12:12 PM

    Hi, so this was dated 2012. I read where guardian, mass mutual and North West ten insurance had dividends of over 5 percent recently. Are you still saying that those dividends over 29 years are nothe worth it?

    Reply
    • Neal Frankle, CFP ® says

      April 3, 2017 at 4:38 AM

      If you read my other post https://wealthpilgrim.com/term-life-insurance-vs-whole-life-insurance/

      you’ll have your answer!

      Thanks,
      Neal

      Reply
  2. David says

    February 6, 2017 at 1:07 PM

    Huh? If I own a life insurance policy on my life and change the beneficiary from my estate or living trust to, say, a child of mine, there is no change in the “incidence of ownership.” I still own the policy and its value will still be included in my gross estate.

    Reply
    • Neal Frankle, CFP ® says

      February 6, 2017 at 1:50 PM

      Thanks David. I clarified the post.

      Reply

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Are You Human? * Time limit is exhausted. Please reload CAPTCHA.

Primary Sidebar

Who is Neal Frankle

Neal Frankle

I'm a Certified Financial Planner™ with more than 25 years of experience. I feel very blessed and hope to share my personal financial experience and professional wisdom with readers of WealthPilgrim.
Read More »

Stay Connected

Facebook Twitter YouTube RSS

More Categories

Career Development
College Funding
Credit Cards
Credit Score Fixes
Money and Marriage
Debt Relief
Estate Protection
Property Investment Loans
Small Business Strategies
Spend Less Money

Most Helpful Posts

  • Term vs Whole Life - Which Is Best For You?
  • Who Should Buy Guaranteed Life Insurance?
  • Is Life Insurance For Children A Good Idea?
  • How To Get The Cheapest Term Life Insurance
  • How To Get Inexpensive Senior Term Life Insurance
  • How To Buy Term Life And Save 70%
  • Do You Need Life Insurance At All? Maybe Not.

Disclaimer

Wealth Pilgrim is not responsible for and does not endorse any advertising, products or resource available from advertisements on this website. Wealth Pilgrim receives compensation from Google for advertising space on this website, but does not control the advertising selection or content. Please do the appropriate research before participating in any third party offers. The information contained in WealthPilgrim.com is for general information or entertainment purposes only and does not constitute professional financial advice. Please contact an independent financial professional for advice regarding your specific situation. Wealth Pilgrim does not provide investment advisory services and is not a registered investment adviser. Neal may provide advisory services through Wealth Resources Group, a registered investment adviser. Wealth Pilgrim and Wealth Resources Group are affiliated companies. In accordance with FTC guidelines, we state that we have a financial relationship with some of the companies mentioned in this website. This may include receiving payments,access to free products and services for product and service reviews and giveaways. Any references to third party products, rates, or websites are subject to change without notice. We do our best to maintain current information, but due to the rapidly changing environment, some information may have changed since it was published. Please do the appropriate research before participating in any third party offers.


About · Contact · Disclaimer & Privacy policy

Copyright © Wealth Pilgrim 2021 All Rights Reserved