Do your beneficiaries have to pay tax on your life insurance payout?
If you’re investing in a life insurance policy, clinic paying regular premiums, sales you want to make sure that your beneficiaries get the most possible benefit when you die. After all that’s what the money is for; to make sure they are not financially disadvantaged by the fact that you are no longer around. This being the case you will probably want to know if the lump sum paid out from your life insurance is subject to tax.
Taxation is often an important consideration when it comes to finances as it can reduce the amount received in a transaction by a substantial amount. So is life insurance taxable?
What is the tax situation with life insurance?
The simple answer is that the majority of life insurance lump sum payments are not subject to tax. This is mostly because the insurance is paid for with income that has already been subject to tax. If the payout was then also taxed this would lead to a double tax situation. This is the type of situation that the IRS likes to try and avoid. If you happen to be a wealthy individual then it’s possible that estate tax may come into play.
The estate tax ceilings (the amount above which tax is payable) are in the millions of dollars, so they do not apply to the vast majority of people. If they do apply to you then it’s worth taking action to remove your life insurance policy from your estate; this means that it will escape being subject to estate tax.
How can you prevent your life insurance being included in your estate?
Your estate at the time of your death consists of everything that is owned by you, both money and items and property that are of value. This is why, if you think that estate tax may be an issue, you need to make sure that your life insurance is not in your name. You will need to transfer the insurance to a responsible adult. They then became responsible for payment of the premiums and only they can make any changes to the policy.
This is why it’s import to consider the transfer very carefully. Any change has to have been made at least three years before you die, so it’s important you find someone who is reliable and who you are going to have a continuing stable relationship with. If you die within three years after the transfer is made then the lump sum is included in your estate as it would have been if the transfer had not taken place.
Is there any other situation where taxation will be an issue?
The only other time that you may have to worry about tax on a life insurance payout is if you choose for the sum to be paid to a company to then be paid to your beneficiary at a later date, or if your beneficiary elects to receive the amount in installments. In these cases, any interest accrued is subject to taxation.