Once again, tax season is here. If you’re like a lot of Americans, you probably have questions about life insurance and any payouts you’ve received within the last year. When preparing your documents for tax purposes, you might wonder, do you pay taxes on life insurance? What tax forms are required for filing?
Quick Links
- Is Life Insurance Taxable?
- What You Need to Know About 1099 Forms for Life Insurance
- Do You Pay Taxes on Life Insurance Premiums or Payouts?
- What You Can Do With Life Insurance Proceeds
Is Life Insurance Taxable?
One of the main benefits of life insurance is the death benefit provided to beneficiaries after the policyholder passes away. But, when receiving this money, you may be left wondering: do you pay taxes on life insurance?
Generally, life insurance proceeds received by the beneficiary aren’t taxable, but this isn’t always the case. There are some instances when either beneficiaries or policyholders will be required to pay taxes on their proceeds. For example:
- Money has been withdrawn from your policy: Some whole life insurance policies have an option to withdraw cash value from the interest that has accumulated overtime. When this money taken out exceeds the amount of the premiums paid, you will need to pay taxes on that amount.
- Surrendered policy: If you would like to terminate your policy, the proceeds received that are more than the policy’s cash basis will be taxed as a form of income.
- Employer-Sponsored Group Life Insurance: If the money paid out from a group life insurance policy is more than $50,000, the payout may be taxable.
- Payout installments: When a death benefit or annuity is distributed in a single lump-sum, the payout is tax advantaged. However, when the payouts are received in installments, those funds will be taxed.
If you receive a 1099 Form from your bank or insurance provider, that likely means you received earnings from your policy or a policy you are a beneficiary on, and you’ll need to file taxes for those earnings.
What You Need to Know About 1099 Forms for Life Insurance
IRS Form 1099 is intended to help both the IRS and taxpayers understand how money is earned and where it’s coming from, particularly for non-employment income.
The 1099 has a few forms you should know about: 1099-INT, 1099-R, and 1099-DIV. All of these forms are used to report income earned, but each 1099 has a more specific application for use, such as the type of financial vehicle used to earn income.
The 1099-INT form is used to report interest on some insurance policy proceeds. This form will need to be filed if more than $10 in interest is earned on:
- Accumulated dividends
- Any premiums that were paid in advance
- Maturity benefits
- Refund of premium
- Death benefit proceeds between the date of death and the settlement
When it comes to life insurance and annuities, you might be more familiar with the 1099-R form. This form is filed when:
- Distributions are received for a retirement account, annuity, IRAs, or insurance products
- You took out a loan on a retirement plan
- You received permanent and total disability payments from a life insurance policy
- A policy has been surrendered with a gain
A third form to know about is the 1099-DIV form, which is used to report dividends received. This includes both ordinary and qualified dividends, as well as capital gains from investments.
In some cases, 1099 forms are used as simple record keeping and no taxes will need to be paid when the form is filed. But a good rule of thumb is you’ll need to submit a 1099 form for any income earned as a result of a life insurance or annuity product.
In addition to these three 1099 forms, there are several others available. However, those are required for specific instances often unrelated to life insurance and annuity products. For further information on the different types of 1099 forms, be sure to turn to the IRS website.
Do You Pay Taxes on Life Insurance Premiums or Payouts?
Life insurance and annuities are popular products for financial coverage and stability. In particular, they are popular for their tax benefits. As stated previously, death benefits when received as a lump-sum don’t require taxes to be paid.
That being said, there are some exceptions to the tax advantaged rule, one being annuity payouts. Annuities are beneficial because they can be received as regular income during retirement. However, there will be some income tax associated with those payouts.
While still a form of payment, the IRS doesn’t treat life insurance payments like other sales. Instead, there is no federal sales tax on life insurance premiums. That being said, some states may require a small tax percentage on top of premium payments.
Whole life insurance policies are tax-advantaged, though. The policy will grow in value, tax-deferred. This means that taxes will only need to be paid until they receive a payout from the policy. And, policyholders will only need to pay taxes on the difference between the total premiums paid toward the policy and the cash value received.
Let’s break this down a little bit. If you paid a total of $25,000 in premiums toward your whole life insurance policy, and you cash out the policy for a $32,000 value, you would need to pay taxes on the $7,000 difference.
If you’re unsure about the taxes required for life insurance payouts, the IRS has provided this online interview to help answer any questions. If you have all of your policy information ready to go, this interview should only take a few minutes.
What You Can Do With Life Insurance Proceeds
One of the main benefits of life insurance is the proceeds that are paid out to individuals, known as death benefits. With these funds, beneficiaries can pay off debt, make donations to meaningful organizations, save for college loans, or make contributions toward end-of-life expenses. In short, the proceeds received from death benefits are up to the recipient’s discretion.
That said, the policyholder may have had a certain intent in mind when originally applying for a whole life insurance policy. In fact, many people choose to apply for life insurance in order to leave an inheritance, or to help cover the costs of expenses they may be anticipating, such as a long-term care rider for medical expenses.
No matter the reason behind purchasing life insurance and annuity products, there are all kinds of products available to help you meet your financial goals, and many of them have notable tax benefits. As you begin filing your taxes this year, don’t hesitate to reach out to an independent insurance agent from ELCO Mutual to help answer any questions. For more information about whole life insurance and annuities, get in touch with us today!
