Do you pay taxes on life insurance benefits? It’s a fair question, and it should be part of the overall assessment of your insurance needs. After all, it’s hard enough when trying to calculate what your beneficiaries will need if you were to pass away, and tax complexities could completely throw off your calculations. While in general most life insurance plans are not taxed upon maturing, there are exceptions to this rule. Though there will not be income taxes there may very well be federal estate taxes on life insurance payout, depending on the circumstances surrounding the payout of the plan.
If you are above a certain level in total assets, and the life insurance benefit is included in your estate then estate taxes may come into play. Also, if you bought the policy from the original owner, you may very well face income tax on the death benefit payout.
You may have heard the concept of a ‘fat tax’ in relation to life insurance, in which a person who is or becomes morbidly obese while making payments to a life insurance plan may see an increase in their premiums due to the increased medical risks associated with the obesity. Just to be clear, this is not a government tax on life insurance; rather it’s simply an increase in the overall yearly premiums due to the increased health risks associated with the condition.
So it is important to bear in mind that generally there are no income taxes on life insurance proceeds, but they are not necessarily estate tax free. On top of all of this, if one dies before all the payments to the plan are made, then there may be some liability for excess taxes whereas one who lives past the maturity of the plan will quite often have less taxation on the policy when it gets paid out to the heirs. It is therefore very important to choose a plan that will most likely mature before your departure as a means of preventing your benefactors from losing a large portion of their inheritance. It is imperative to speak to a tax advisor prior to selecting a life insurance policy, to determine which one is best for your situation, as they know the most about the taxation laws pertaining to you and your locale. And as tempting as it might be to simply shop for life insurance online, a good life insurance agent can help with questions about taxes on life insurance too.