Taxation of Term Life Insurance
Term life insurance is one of two life insurance types available in the United States along with permanent life insurance. When it comes to taxing term life insurance benefits, payouts can be considered taxable income depending on how the insurance premiums are paid and the amount of the death benefit.
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Types
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There are three main types of term life insurance policies available for purchase: increasing term, decreasing term and fixed term plans. Increasing term life insurance, which is a standard term policy, has initial premiums that are low and will increase over time. Decreasing term life policies have premiums that will reduce over time. A fixed term plan will have level premiums throughout the time the policy is in force.
Benefits
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Term life insurance plans only cover insured for a set period of time, which is chosen by the applicant. Coverage can be bought for 5, 10, 20 or even 30 years. Term life insurance policy owners are only paying for insurance and no other features such as investment options, which are available with permanent life plans. Therefore, these plans are much cheaper than whole life and universal life policies. For example, a 40-year-old nonsmoking male can get a $250,000 20-year fixed term life plan for only $350 a year, while a universal life plan for the same benefit amount will cost him almost $3000 in annual premiums, according to MetLife.
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Taxation
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Insurance benefits from term life insurance plans are not considered taxable income if the premiums are paid with after-tax dollars. That is typically how premiums for individually owned policies are paid.
However, group term life insurance plans, which cover a group of people, are generally paid for by the plan's sponsor such as an employer. Since the premiums paid by the employer can be deducted as a business expense, the insurance payout can be taxed as income to the beneficiary. This will happen if the benefit amount exceeds $50,000. Also if the spousal and dependent coverage is above $2,000, then the death benefit will also be subject to taxation.
Misconceptions
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Term life insurance policies may be equipped with clauses that will permit the policy owner to either renew their policy for additional years or even convert it to a permanent life insurance plan. The renewability clause will extend the term policy without providing evidence of insurability. Term policy owners who have a conversion clause in their plan can upgrade their policy to a whole or universal life policy without providing medical documents to prove their health. They will have to provide evidence of insurability if there is a change in the benefit amount or if they miss the conversion period.
Warning
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Term life policies do not earn value over time or have any features that are found in permanent life insurance plans. Once the term expires, the coverage will be terminated. Also, if the policy owner decides to purchase another term policy after the previous plan has ended, their premiums will increase even if they are healthy at their age.
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References
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