Do beneficiaries pay taxes on life insurance?
The main purpose of life insurance is to provide financial support to your loved ones after your death. It is important to know what tax you may be subject to if you are the beneficiary of a life insurance policy, especially when the death benefit is significant. This guide will help you understand whether or not beneficiaries pay taxes on life insurance.
The death benefit of a life insurance policy is the amount of money payable to one or more named beneficiaries on the death of the insured person, provided the policy is in good standing and the claim is accepted. The death benefit amount will vary by policy type and insurer, but can range from a few thousand dollars to over a million dollars. This payment is tax-free and can be paid all at once or over time. However, any interest earned on the death benefit is subject to tax.
A life insurance beneficiary is a person or persons, or an entity named as the beneficiary of a policy’s death benefit. A beneficiary can be a spouse, dependent, parent or anyone you choose. Entities such as a charity, church, or educational institution can also be named as beneficiaries. You can also designate your estate as the beneficiary of the policy.
There is a lot of flexibility in how you designate beneficiaries. You can name more than one beneficiary to split the payment and assign an amount or percentage of the death benefit to each. You can also have alternate beneficiaries by naming primary and contingent beneficiaries.
For example, you can designate your spouse as the primary beneficiary and an adult child as the contingent beneficiary. This means that if you predecease your spouse, they will receive the full death benefit. However, if your spouse predeceases you, the entire death benefit will go to your contingent beneficiary, in this case your child.
The IRS does not consider death benefit proceeds to be taxable income. However, the interest earned on this sum after your passage is taxable. For example, if you ask the life insurance company to delay the transfer of the death benefit for a few months, the lump sum will earn interest while it is held. If you have elected to receive monthly installments, funds that have not yet been disbursed will also earn taxable interest. If you plan to name your estate as the life insurance beneficiary, the amount could push the estate into a federal tax area. The 2022 limit before an estate is taxed is $12.06 million.
The attribution of beneficiaries is essential to ensure that the death benefit is paid as you intend. If you fail to name a beneficiary on your life insurance policy, this money will be transferred to your estate upon your death. It will be up to a probate court to distribute your assets to your heirs, a time-consuming process that could result in legal fees and other expenses that diminish the size of your estate.
There are several ways to pay a death benefit. The most common is a lump sum, which is the full amount at a time. However, if you are the beneficiary, you can also ask the insurance company to pay installments over a specific period of time.
Life insurance premiums on a personal policy are generally not tax deductible. However, if you own a business, you may be able to deduct premiums paid on behalf of employees. The rules for doing this can be complex, so you should consult a licensed tax professional if you have any questions.
There is no time limit to file a life insurance claim after the death of the insured. Following the death of the insured, a beneficiary can file a claim in a few steps.
Gather the appropriate documents
- A government-issued death certificate showing cause of death and date of death
- The social security number, legal address and full name of the deceased
- A copy of the insurance policy with the policy number
- A copy of the form for claiming insurance benefits, called a claim for benefits or claim for benefits
If you cannot find the actual policy document but know which insurance company issued the policy, you can contact the insurer for assistance. If you are unsure which company issued the policy, the National Association of Insurance Commissioners (NAIC) website has a policy localization tool it can be useful.
Complete the benefit application
The claim form will ask you for details found on the documents you collected, such as the cause of death and the policy number or social security number of the insured. You will also be asked questions about your relationship to the deceased, your contact information and how you would prefer to receive the death benefit payment.
Once the claim for benefits has been filed, the insurance company will process the claim. It may take some time for the company to verify that you are the beneficiary and confirm that the policy has not expired. Although some companies aim to resolve claims in as little as 24 hours, it is possible for a claim to take 30-60 days to resolve.
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