Will My Beneficiaries Have To Pay Taxes On My Life Insurance Policy?


Click here to read an update to this article published December 2022. 

Under current law, death benefit proceeds from life insurance are generally income tax-free. If you name a spouse, child, or other individual as a beneficiary to a life insurance policy you own, that person will not have to report any of the proceeds as income due to your death.

If a beneficiary elects to receive the death benefit in installments instead of a lump sum, any interest portion of the payments is taxable as ordinary income. If a beneficiary keeps the proceeds with the insurer rather than taking receipt, and the proceeds are held in a savings account, any interest earned on the balance would also be taxable. Insurers may use terms such as “assurance” or “access” to market these types of accounts. In these cases it is always important to comparison shop and review any administrative or maintenance fees, for example what the insurer is offering compared to similar bank savings or checking accounts. One insurer was recently paying 0.110% on a six-figure deposit, when 1.00% was available from a bank.

The income tax-free nature of life insurance makes it a valuable tool for family protection, liquidity and wealth transfers. The best-intentioned plans, however, can go awry if life insurance details are not well incorporated into a complete financial plan.

These are two scenarios where missteps, or missed opportunities, could impact the tax treatment of life insurance:


If you transfer the ownership of your policy for cash before your death, the income tax exclusion for the death benefit proceeds may be limited to that sum paid by the new owner. In other words, some or all of the proceeds at your death could be considered taxable income to that beneficiary. Before transferring the ownership of a policy, it is wise to seek the assistance of a tax professional and evaluate the potential consequences.


All of the above relayed the good news that life insurance proceeds are normally never taxed as income. However, life insurance may be taxable as part of an estate. If you control the policy in any way (what is known as an incident of ownership of the policy), the proceeds may be subject to estate taxes when you die. You may delay estate taxes if the proceeds are payable to a spouse, but the taxes may come due later upon the second to die. However, with the current federal estate tax exclusion amount at $5,490,000 per person in 2017, most estates (and surviving spouses) will not owe an estate tax at the federal level.

While most people will not be subject to federal estate taxation, the state in which the decedent died may have an estate or inheritance tax that operates independently of the federal tax. In some cases, state exclusion amounts are materially lower than the federal amount. For example, if a Massachusetts gross estate exceeds $1,000,000, a Massachusetts estate tax return must be filed and the maximum rate is 16%.

Life insurance established (and properly maintained) under an Irrevocable Life Insurance Trust (ILIT) may avoid the incidence of ownership rules imposed by tax authorities. For those who may be subject to a state or federal estate tax, use of an ILIT can preserve the income tax free properties of life insurance and reduce or eliminate estate taxes.

Complicated rules along with competing financial goals requires exercising caution before making an irrevocable decision with life insurance. Good planning may be simple in some cases, while other circumstances warrant advanced techniques to preserve wealth and reduce taxation. Avoid problems by keeping your professional advisors informed of current policy data and changes to your circumstances or goals.

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