Income Taxation of Life Insurance Policies

Life insurance is a good investment that gives peace of mind to the insured in knowing that their final expenses will be covered. It also allows the insured to provide some extra money to loved ones. There are income tax liabilities under certain circumstances.

Cash Values

Whole life insurance policies offer cash value accumulations that can be withdrawn by the policy holder. These cash value withdrawals do not have to be repaid. The amount of the cash value that exceeds the amount of premiums paid and dividends earned is taxable as ordinary income the year in which it becomes available.

Policy Loans

There are no income taxes owed on policy loans. If the policy is surrendered, taxes will be owed on any amount greater than premiums paid and dividends earned.

Death Benefits

Death benefits paid to a beneficiary after the death of the insured are not subject to taxation.

Interest Earned

If the death benefits are left with the insurance company for investment by the beneficiary, the interest earned on the death benefit will be taxed.

Surrender

Surrender of the policy will incur income tax liability on the portion of the surrender value greater than the premiums paid and dividends earned.

Dividends and Premiums

Dividends are never taxable as they are considered a return of premium. The amount paid in premiums is never taxed since the premiums are paid by the policy holder with income that has already been taxed.

References

• World Wide Web Tax: Do I have to pay tax on my life insurance interest?
• Trusts & Estates: Life Insurance and Income Tax