- What taxes apply to a life insurance death benefit?
- August 8, 2013
The common misconception is that life insurance is not subject to taxation, which is half-true and half-false. Life insurance is almost always not subject to income taxation; however, under current tax law (2003), it is still subject to estate taxation.
As a general rule, life insurance death proceeds are excusable from the beneficiary’s gross income (IRC Sec. 101(a)(1)).
Death proceeds from single-premium, term life insurance, periodic-premiums, or flexible premium life insurance policies are received income tax free by the beneficiary regardless of whether the beneficiary is an individual, a corporation, a partnership, a trustee, or the insured’s estate (Treasury Regulation 1.101-1).
However, the death benefits may be subject to estate taxes, gift taxes, and any other inheritance tax.
This is a good reason to visit with an estate-planning professional – somebody who is appropriately licensed and qualified.
How to roughly calculate your potential estate tax:
1. Total you gross estate; including anything of value in which you have an ownership interest. For example, home and other real estate; retirement plan balances; stocks, mutual funds and other investments; and businesses and life insurance proceeds (not held outside your estate).
2. Subtract all allowable deductions, such as funeral and administrative expenses, mortgages, loans, credit card debt, charitable deductions, etc.
3. If you have a positive net estate, this is your net taxable estate.
4. Use the table below to calculate your tentative estate tax.
Year Exemption $ Maximum Tax Bracket Unified Credit 2011 $1 million 45 percent 245,800 2013 & beyond $5.25 million 40 percent $1,772,800
Your unified credit is subtracted from your tentative tax, if unused during your lifetime. The unified tax credit means that no federal estate tax is payable on a taxable estate equal to your exemption equivalent. Estate taxes are due when your tentative tax is greater than your unified credit.
Your estate may be valued at death or six months later, whichever is more beneficial. If you own a farm or closely held business, your method of paying taxes will be different.
Use this information to generate a rough idea of your potential estate tax. Be sure to check out the IRS website or consult with a properly certified estate-planning adviser.
Note: This information is based on certain life insurance policy, tax, and legal assumptions, but it not meant as legal or tax advice and is, also, subject to change. Only your attorney, accountant, or other tax professional can give you such advice. Please consult your tax adviser as rates and exemptions may be subject to change.
About Tony Steuer
Noted insurance author Tony Steuer has spent over 25 years in the life insurance industry. Steuer’s leadership roles include serving on the California Department of Insurance Curriculum board and the National Financial Educator's Council Curriculum Advisory Panel as well as having served as President of the San Francisco Chapter of the American Society of CLU & ChFC, President of the leading Life Insurance Producers of Northern California, and as a board member of the San Francisco Life Underwriters Association. Mr. Steuer is the author of Questions and Answers on Life Insurance: The Life Insurance Toolbook, The Questions and Answers on Life Insurance Workbook and The Questions and Answers on Disability Insurance Workbook - the first two were awarded the “Excellence in Financial Literacy (EIFLE) Award from the Institute of Financial Literacy. Steuer holds a Chartered Life Underwriter (CLU) designation and also holds the Life and Disability Insurance Analyst License, a designation that is held by less than thirty people in California.
Questions & Answers on Life Insurance by Tony Steuer, CLU, LA, CPFFE is licensed under a Creative Commons Attribution 3.0 Unported License.