When Is Life Insurance Taxable? Four Scenarios to Consider
While life insurance is typically not taxable, there are some notable exceptions that could play a role and are important to consider regarding any life insurance policy and benefit.
Do Beneficiaries Pay Taxes on Life Insurance?
Typically, a life insurance benefit is paid to the beneficiary in a lump sum, which is not taxable. However, the beneficiary may elect to receive the policy amount in installments. In this case, the benefit is placed into an account that can accrue interest. While the beneficiary will not pay taxes on the benefit itself, they will be responsible for paying income taxes on any interest accrued.
Steven is the beneficiary of a $500,000 death benefit that earns 10% interest for one year before being paid out. Steven will owe income taxes on the $50,000 in interest growth.
2. Is Life Insurance Subject to Estate Taxes?
The death benefit of a life insurance policy is typically paid directly to the beneficiaries named. In the case that the benefit is included in the estate, it is subject to potential Federal and State estate taxes if it is above the tax exemption amount:
The Federal exemption is currently $12.92 million for a single person, and nearly $26 million for a married couple.
About a dozen states have state estate taxes with exemptions varying between $1 million and $9.1 million.
If the death benefit amount is above these exemptions, any amount above the threshold would be subject to estate taxes.
3. Policy Riders and Taxes
Policy riders are optional features that can be added to a life insurance policy to help cover life events that a standard policy does not. These riders are typically not subject to taxes but would reduce the amount that your beneficiary receives.
WAEPA’s Chronic Illness Rider allows policyholders to collect up to 50% of their Group Term Life Insurance benefit to help cover the costs of a chronic illness. This tax-free benefit is paid directly to the policyholder over a four-year period, to be used as they see fit.
Learn more about WAEPA’s Chronic Illness Rider >
4. Avoiding the Goodman Triangle
A life insurance death benefit would be subject to taxes in the event of a taxable gift. This happens when three people serve three different roles in connection to the policy:
The policyholder: the person who purchased the policy and is responsible for payment of the premiums.
The insured: the person whose life is covered by the policy.
The beneficiary: the person who receives the death benefit when the insured passes away.
Say Robert purchases a life insurance policy for his wife Barbara. They name their son Cody as the beneficiary. If Barbara passes away and Cody receives the death benefit, the IRS considers this a taxable gift from Robert to Cody, as Robert was the policyholder. This is also known as a “Goodman triangle” and in this case, the policyholder, Robert, may have to pay gift taxes for any benefit amount that exceeds Federal gift tax exemption limits:
The annual gift exclusion is $16,000 per individual
The lifetime limit is $12.06 million per individual
To avoid this scenario, Barbara could purchase and make payments on a policy herself, with Cody still named as the beneficiary.
While life insurance is not typically taxable, these scenarios should be considered when purchasing a life insurance policy and estate planning.
See WAEPA’s library of estate planning resources >
Join WAEPA
One of the greatest gifts you can give your family is peace of mind. Help secure their financial future, even if you were to pass away. One of the only inevitable parts of life is death. Having a life insurance policy helps to prepare you and your family for the certainty of death.
The unique value of a WAEPA membership:
WAEPA’s rates can cost less.
Typically, WAEPA members get a partial premium refund every year.
WAEPA offers several auxiliary member benefits.
WAEPA coverage is fully portable: even if you change jobs or retire.
WAEPA’s coverage is not capped by your salary.
1Please consult a qualified tax advisor to review your specific circumstances
2Investopedia, “Do Beneficiaries Pay Taxes on Life Insurance?” 2022 Dec 7.
3Investopedia, “Estate Tax Exemption: How Much It Is and How to Calculate It,” 2023 Feb 16.
4Tax Foundation, “Does Your State Have an Estate or Inheritance Tax?” 2022 June 21.
5Including features, costs, eligibility, renewability, limitations, and exclusions
6Forbes, “Is Life Insurance Taxable?” 2023 Jan 4.
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5. Paying for College
Women with children should consider the cost of college in their life insurance decision, especially given the rising costs of secondary education. U.S. News reported the average cost of tuition and fees for the 2022-2023 school year.
· Private Colleges: $39,723
· Out-of-State Students (public colleges): $22,953
· In-State Students (public colleges): $10,423
Life insurance can help alleviate this cost in the event of the death of a parent, ensuring your child can continue their education with minimum financial stress.
6. Living Benefits for Chronic Illness
If you know anyone who’s suffered from a long-term illness, you know how difficult it can be.
There are a range of long-term illnesses which affect women more commonly than men. 90 percent of those with lupus are women. 80 to 90 percent of chronic pain diagnoses, such as fibromyalgia, are given to women.
WAEPA offers a Chronic Illness Rider, which can be added to a Group Term Life Insurance policy to help cover the cost of care that a chronic illness can require.
7. Life Insurance For Women is Affordable
WAEPA’s coverage is exclusive to current and former Civilian Federal Employees. Given that our rates are calculated for the group rather than for individuals, members often save money on premiums compared to other life insurance policies. Members who switched to WAEPA from FEGLI save an average of $300 per year.
Here’s what a 40-year-old woman would pay for $500,000 in coverage with WAEPA:
$29.40/monthly
Use WAEPA’s free premium rate calculator to see how much you could save.
8. Protecting Your Business
According to the National Association of Women Business Owners, there are a total of 12.3 million women-owned businesses in the U.S. For business owners, life insurance can provide protection for the family, company, business partners, and employees if the owner passes away. Your policy could be used to pay off debts or keep the business afloat if needed.
Additionally, with a family business, a life insurance policy can ensure that everyone gets an equal inheritance. One child might inherit the company shares, while the other receives the insurance payout.
9. Peace of Mind
Life insurance for women is a critical financial planning strategy, regardless if you are single, a female breadwinner, or stay-at-home mom. With coverage from WAEPA, you can be confident knowing that your family’s financial future is secure.
Other Exclusive WAEPA Membership Benefits:
· WAEPA’s rates can cost less
· Typically, WAEPA members get a partial premium refund every year.
· WAEPA offers several auxiliary member benefits.
· WAEPA coverage is fully portable: even if you change jobs or retire.
· WAEPA’s coverage is not capped by your salary.
[1]What Women Want in Financial Services, LIMRA, 2022.