What Is the Life Insurance Tax Percentage?
Generally speaking, a beneficiary who receives a lump sum payment of life insurance death benefits does not include the amount as income.
Death benefit payments issued under endowment contracts, worker’s compensation insurance contracts, employer-sponsored group plans, or accident and health insurance contracts are also exempt from taxes.
Dissecting It
Even if a loved one’s death cannot be predicted or anticipated, it is still crucial to engage with a knowledgeable tax and estate planner to prevent the IRS from collecting unnecessary taxes. Therefore, rather than being a “how-to” article, this one should be used as a checklist to ensure that your life insurance policy is in the proper location. To be sure your insurance payouts will go to the correct destination, it is very okay to confirm with your estate planner.
Excess Interest Taxes Paid
The exclusion does not apply if a policy is paired with a non-refund life annuity contract in which the single premium paid is equal to the face value of the insurance. For instance, the extra interest received above the $250,000 face value of the death benefit is taxable if the recipient chooses to receive monthly installments rather than the lump sum amount. Unlike life insurance, an inherited annuity’s potential tax liability may vary depending on the annuity contract’s terms and whether the beneficiary is a surviving spouse.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act’s regulations about when the beneficiary may take distributions and the amount of taxes due may also be applicable if the inherited annuity was a component of the decedent’s defined contribution plan, such as a 401(k). Annuity regulations may be complicated, so it’s crucial that you speak with a knowledgeable tax professional about your tax responsibilities.
Ownership and Estate Planning Difficulties
Although death payments from life insurance policies are often not subject to income tax for the beneficiary, they are included in the deceased’s estate if they were the policyholder at the time of death.
The benefit paid may be liable to both federal and state estate taxes as a result of its inclusion as part of the estate.
If the life insurance policy’s owner is someone other than the dead, estate inclusion can be avoided; however, this assignment needs to have taken place more than three years before the death date, otherwise the IRS will still regard the deceased as the policy owner for estate tax reasons.
The Bottom Line
It is crucial to confirm with your financial adviser that your investments are in the appropriate location, even if a life insurance policy would not tax the recipient by default.
Tens of thousands of dollars in avoidable taxes can be avoided by avoiding the aforementioned mistakes.