Understanding When Life Insurance is Taxable

Understanding When Life Insurance is Taxable

You have your life insurance policy, but you are confused about whether taxes are associated with it or not. It is important to know if life insurance is taxable.

Taking a life policy to secure the future of your family is a great move. However, it’s also smart to learn about any tax implications. This article will enlighten you on this subject.

Payout and Taxes

The payout from a life policy is called a death benefit. Since it is not considered gross income the payout is not taxable.

Estate Tax

If no beneficiary claims the death benefit, the payout will roll into your estate and as a result, will be taxed with your estate. However, if a death benefit is transferred into a family trust, it’s not taxable.

Unholy Trinity and Gift Taxes

Sometimes a gift tax is added to a life insurance policy when the policy owner, the insured, and the beneficiary are three different people or establishments. This tax trap is often called “unholy Trinity” or “Goodman Triangle”.

Cash Value and Taxes

In most cases, whole life policies have a cash value, which can be withdrawn from that policy. If the cash-value withdraw does not exceed the total amount of premiums you have paid, that cash withdraw is non-taxable.

Other Taxable Incomes

Modified Endowment Contract (MEC) occurs when you have paid too much into your policy in the first seven years, exceeding the federal tax law limits. This classification change from a life insurance policy to a MEC triggers taxes on any gains. For lump-sum payouts, the death benefit accrues interest, which is taxable.

Other Non-Taxable Incomes

Accelerated Benefit Rider (ABR) medical emergencies and partial withdrawals from your policy are not taxable.

Understanding the tax implication of your policy will help you save money where necessary. Are you looking for help with your life insurance coverage? If so, then contact the experts at Steve Wilk Insurance. Check out our new office today at 310 S Main Street, Suite C, Lombard, IL 60148.