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Tax On A Life Insurance Policy

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No income tax is payable on earnings in a life insurance policy during the life of the policy.

At death, no income tax is payable -- including on the difference between the amount that was paid into the policy and the death benefit.

Contrary to popular belief, the death benefit will be included in the insured's estate if he or she was the owner of the policy. Beneficiaries receive proceeds from life insurance policies income tax free.

Estate Tax

For estate tax purposes, the amount of a death benefit of a life insurance policy is included in the owner's estate. Even insurance policies in a revocable living trust are included in the estate of the person who set up the trust (generally the owner).

The question of ownership becomes important if the size of the owner's estate, including the proceeds from the life insurance policy, exceeds the threshold subject to federal income tax. The threshold in 2013 is $5,250,000.

The identity of the beneficiary or beneficiaries is not important -- unless you name your estate as beneficiary.

If you wish to remove a life insurance policy from your estate, change the ownership of the policy to another individual or transfer ownership of the policy to another entity such as an irrevocable trust. If you have a question about a change in ownership or how to create an irrevocable trust, consult an attorney, tax accountant or professional life insurance broker.

NOTE: If you own a life insurance policy but want to remove it from your estate for estate tax purposes, ownership must change at least three years prior to your death in order to successfully eliminate the policy from your estate for estate tax purposes.

Income Tax

Permanent life insurance policies have an interest earning feature. Like money in a retirement account, this money is not taxable while it accumulates during the insured’s life time.

There is also no income tax payable on the insured’s death if there is a difference between the amount paid for the policy and the death benefit. For example, an insured with a $100,000 life insurance policy dies after only paying $10,000 in premiums. There is no income tax payable on the $90,000 difference ($100,000 less $10,000).

NOTE: For the tax consequences of a sale of a life insurance policy, see: Tax Consequences Of A Sale Of A Life Insurance Policy.


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