If you’ve received a life insurance benefit, you might wonder if you need to pay taxes on that benefit. Or, if you’re considering purchasing life insurance, it’s important to know whether your beneficiaries will need to pay taxes on the insurance benefit. Understanding how life insurance works and how benefits are taxed can help you to plan and manage your money well.
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When you purchase a life insurance policy, you will identify a policy beneficiary. If your policy is still in effect when you pass away, the beneficiary will receive a benefit. Benefits are often paid out as a lump sum, but certain types of benefits, like annuities, are issued as multiple payments.
Beneficiaries can use a life insurance benefit to pay for:
A life insurance benefit provides financial support to families, helping them to navigate what could be a financially difficult time because of the loss of the income you would have contributed to the family
So, are life insurance proceeds taxable? In most cases, no. Beneficiaries who receive a lump sum death benefit aren’t required to report the benefit in their gross income, meaning it doesn’t have to be reported as taxable income.
However, if the benefit is an annuity, it can be issued in multiple payments. In that case, the payments can include proceeds and interest from the life insurance policy, and the interest portion of the payments are taxable.
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Life insurance benefits may be taxed if you have set up your policy so that your benefits become part of your estate. Depending on the taxable value of your assets when you die, the IRS may levy an estate tax.
For 2024, the federal estate tax exemption limit is $13,610,000 for an individual. If you die with an active life insurance policy, the value of that policy’s payout is included in your estate. And if the total value of your estate is more than $13,610,000, your beneficiaries would have to pay estate taxes on any value that exceeds that tax exemption limit.
However, if you choose an individual as your beneficiary, instead of your estate, the individual won’t be responsible for paying estate taxes. Instead, they will receive the benefit tax-free.
There are many benefits to buying a life insurance policy, including the fact that in many cases, lump sum benefit payments are tax-free. If you have limited savings, have substantial expenses like a large mortgage payment, or simply want the peace of mind of knowing that your family will have financial support if you pass away, then investing in a life insurance policy could be a great idea. To get started, get a life insurance quote today.
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Paige Cerulli Paige Cerulli is a freelance content writer and journalist who specializes in personal finance topics. She graduated from Westfield State University and brings more than a decade of professional writing experience to the ConsumerCoverage team. Paige’s work has appeared in outlets including USA Today, Business Insider, and more.
