The question of being taxed on a life insurance policy is a serious one for all involved. If you are considering taking out a life insurance policy, you likely with to make certain that your loved ones are provided with all they need. When you choose the lowest possible payout, a tax on that money may cause your loved ones undue harm. If you are the beneficiary to a recent policy, you may be concerned about the amount you can use for everyday needs and the amount that needs to be set aside for taxes.
Federal Taxes on Life Insurance
When a person purchases a life insurance policy, a beneficiary is named. The beneficiary is one person who receives the payout after the person has died. As a beneficiary, you are not subject to federal tax on the life insurance policy. The policy was paid post-tax, meaning that the original purchaser of the policy has already paid income tax on the money used to buy the policy itself.
An exception to this rule is if the life insurance is left payable to the estate rather than an individual. If the estate is taxed, the life insurance is considered part of that amount. Current U.S. laws tax estates that are worth more than $5.25 million, according to the Internal Revenue Service.
State Taxes on Life Insurance
In general, states do not consider life insurance payouts as part of regular income. Therefore, these payouts are not taxed. However, 17 states and the District of Columbia do currently charge estate taxes if the policy does not name a particular beneficiary. Most states require that you inherit a state worth more than $1 million. Many of these states are phasing out taxation on death.
Taxation on Early Payouts
Owners of a whole-life policy have the option to withdraw certain amounts, depending upon the type of policy. As long as the withdrawal amounts do not exceed the basis. There is an exception to this if you have a modified endowment contract or if the withdrawal causes ill-effects to the benefit. This is usually not an issue if withdrawals are made 15 years or more after they were purchased.
Taxation on Gifts
As the beneficiary of a life insurance policy, you may wish to apportion the policy to other survivors. As of 2013, you may gift up to $14,000 without accruing tax. Beyond this, you will need to complete an IRS Gift Tax Form.