What Is A Tax Free Death Benefit For Life Insurance?

What Is A Tax Free Death Benefit For Life Insurance?

Life insurance can be very confusing. There is so much to learn before making a final decision. When tax concerns come up, figuring it all out may seem downright overwhelming.

When Is The Death Benefit Tax Free

Generally, the death benefit received from an individually owned policy is tax free to the beneficiary. The reason is because life insurance is considered to be a monetary replacement of a loss and losses are not taxable.

However, any additional income may be subject to taxation. Some policies pay interest, which is taxable. This is not to be confused with dividends. In life insurance, dividends are considered to be refunds of overpayment of premiums and are therefore not taxable.

Group policies and employer owned life insurance policies are not taxable up to the first $50,000 in death benefit and $2,000 for dependant benefits. In other words, someone other than the insured or the beneficiary paid for the policy so the death benefit is considered taxable income.

The Way It’s Paid Makes A Difference

Life Insurance death benefits may be paid in a lump sum. If the beneficiary receives more money than the policy face amount, any additional money is taxable. For example, if the face amount is $75,000 and the beneficiary receives $75,500, the additional $500 is taxable.

If the life insurance beneficiary chooses to take the death benefit in regular installments, part of that money is excluded and part is taxable. To find the excluded amount, divide the life insurance death benefit by the number of years the payments are to be received. If there is no beneficiary designated, the death benefit will go to the estate where it will be subject to estate tax.