Is it Necessary to Pay Taxes on Life Insurance Distributions?

Taxation of life insurance depends on the type of distribution.

The Internal Revenue Service provides detailed information on the taxation of distributions from life insurance policies. Taxation of life insurance distributions depends on several factors, including the type of distribution.

Types

Life insurance death benefits are not subject to income tax. Distributions made prior to the death of the insured may be taxable.

Cost Basis

Life insurance policy distributions are taxable to the extent the distribution exceeds the policy's cost basis. Determine cost basis by adding all premium payments and subtracting dividends from this total.

Effects

If the cost basis is greater than the distribution, there are no income tax considerations. If the distribution is greater than the cost basis, then there is a tax liability.

Policy Loans

Loans are another form of policy distribution. Loan proceeds are generally not taxable. However, they are taxable if the policy is a modified endowment contract. Your agent or insurance company can tell you if the policy is a modified endowment contract.

Warning

Complex employer-owned plans are subject to different rules. Consider consulting a tax advisor for advice on distributions from split dollar and reverse split dollar plans.

References

• IRS: Publication 525--Taxable and Non-taxable Income
• IRS: Life Insurance & Disability Insurance Proceeds