Insurance Tax Deductions: Is Life Insurance Tax Deductible?

Is life insurance taxable? Well, that’s the good news. It turns out that life insurance provides favorable tax treatment in its own way: death benefits are typically not subject to income tax when your loved ones are the beneficiaries and receive the benefit payout. Each insurance situation is different, and we encourage you to speak to your tax professionals about your personal circumstances. 

Not only may that be a financial relief, but it means that during a time of loss and grief, your family or loved ones won’t have to worry about paying taxes on the money they receive from life insurance benefits—because the benefit payout is not regarded as income. (In certain circumstances, some states might impose life insurance taxes, so it’s worth having a conversation with a tax professional.) Having this financial cushion from your life insurance policy can help offer peace of mind, and possibly long-term security, for the people you love. 

If you die while the policy is active, your life insurance beneficiary will receive a lump sum that they can apply toward retirement, debt, or savings for the future. What they do with the policy payout is up to them. So if your loved ones ever ask, “Do we pay taxes on life insurance?” you can reassure them that the answer is likely no. 

Although most people can’t get a tax deduction for these insurance payments, there are certain exceptions for tax deductions: 

1) You own a small business and offer life insurance as a benefit to your employees.  

Some businesses are able to deduct the premiums they pay for their staff's life insurance. If your business qualifies, you can only deduct life insurance premiums for up to $50,000 of coverage. Note: you can’t deduct these insurance payments if you (or your business) is the beneficiary of a group policy. Similarly, this won’t work if your spouse works for your company, because you’d potentially benefit from the payout. 

2) You give the insurance policy as a charitable gift. 

Transferring ownership of a policy can be a savvy tax move. By giving your life insurance policy to, say, a favorite non-profit organization, or naming a charity as your death benefit beneficiary, you can give yourself a nice advantage at tax time. Because the life insurance policy is a charitable gift, the premiums you pay—or the cash value of the policy (whichever amount is less)—are indeed considered tax-deductible. 

3) You bought an insurance policy for a former spouse. 

Not all divorces count for a life insurance tax deduction. But if you have an alimony agreement that took effect prior to 2019, you should be able to take the tax deduction on your insurance policy. (Alimony agreements after 2019 don’t count for tax deductions because of some recent tax code changes.) 

Is the cash value of universal life taxable? The cash investment portion of your universal life insurance grows tax-deferred (just as a traditional IRA does). That means when the money is withdrawn from the insurance policy, you’ll only owe taxes on the earned interest. 

To get more specific: ‘tax-deferred’ means the accumulation of investment earnings (interest, dividends, and so on) that you don’t have to pay taxes on until you withdraw the money. 

• Financial Dependency: Consider who relies on your income for financial support, such as spouses, children, or elderly parents.
  
• Familial Relationships: Take into account your relationship with potential beneficiaries and their financial needs.
  
• Estate Planning Goals: Determine how life insurance fits into your overall estate planning strategy and how you’d like the death benefit will be distributed among beneficiaries.
  
• Regular Review and Updates: It's essential to review and update your beneficiary designations regularly, especially after major life events such as marriage, divorce, or the birth of children.
  
  

So in certain cases you can deduct your life insurance payments from taxes, but in most cases, you can’t.   

Obviously, life insurance is a major investment, and a deeply personal matter. Regardless of your personal situation, it’s important to discuss any potential implications with a tax professional to correctly determine your deduction eligibility. Be sure to write down your tax and insurance questions ahead of time, so you’ll be fully prepared and ready for tax-deferred interest! Then give yourself a pat on the back for thinking ahead and taking such good care of the people you love, even after you’re gone.