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 liability you might face if you’re the beneficiary of a life insurance policy, especially when the death benefit is a sizable amount. This guide will help you understand whether or not beneficiaries pay taxes on life insurance.

A life insurance policy’s death benefit is the amount of money payable to a designated beneficiary or beneficiaries upon the insured person’s death, provided the policy is in good standing and the claim is accepted. The amount of the death benefit will vary depending on the type of policy and the insurer, but can range from a few thousand dollars to more than $1 million. This payout is tax-exempt and may be paid out in one lump sum or over time. However, any interest that is earned on the death benefit is subject to tax.

A life insurance beneficiary is a person or persons, or an entity named as the recipient of a policy’s death benefit. A beneficiary can be a spouse, dependent, parent, or anyone you choose. Entities such as a charity, a church, or an educational institution can also be designated as a beneficiary. You can also name your estate as the policy beneficiary.

There’s a lot of flexibility in how you designate beneficiaries. You can name more than one beneficiary to share the payout and assign an amount or percentage of the death benefit to each. You could also have backup beneficiaries by naming primary and contingent beneficiaries.

For example, you may name your spouse as your primary beneficiary and an adult child as the contingent. This means that if you pass before your spouse, he or she will receive the full death benefit. However, if your spouse passes before you, the full death benefit will go to your contingent beneficiary, in this case your child.

The IRS doesn’t consider death benefit proceeds as taxable income. However, interest earned on that sum after you pass is taxable. For example, asking the life insurance company to delay the transfer of the death benefit for a few months will cause the lump sum to earn interest while it is held. If you elected to receive monthly installments, the funds that have yet to be disbursed also will accrue taxable interest. If you plan on naming your estate as the life insurance beneficiary, the amount could push the estate into a federally taxable zone. The 2022 limit before an estate is taxed is $12.06 million.

Assigning beneficiaries is essential to make sure the death benefit is paid as you intend. If you fail to name a beneficiary on your life insurance policy, that money will be transferred to your estate when you die. 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 a couple of ways that a death benefit may be paid out. The most common is a lump sum, which is the whole amount at once. However, if you are the beneficiary, you also can ask the insurance company to pay installations over a set period of time.

Life insurance premiums on a personal policy are generally not tax-deductible. However, if you’re a business owner, you may be able to write off 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 questions.

There is no time limit for filing a life insurance claim after the insured person’s death. Following the death of the insured person, a beneficiary can file a claim in a few steps.

Round up the appropriate documents

  • A government-issued death certificate that lists the cause of death and the date of passing
  • The deceased person’s Social Security number, legal address, and full name
  • A copy of the insurance policy with the policy number
  • A copy of the insurance claim form, known as the request for benefits or claim for benefits

If you cannot locate the actual policy document but you know what insurance company the policy, you can contact the insurer issued for help. If you don’t know what company issued the policy, the National Association of Insurance Commissioners (NAIC) website has a policy locator tool that may be of assistance.

Fill out the request for benefits

The claim form will ask you for details found on the documents you collected, such as the cause of death and the insured’s policy number or Social Security number. You’ll also be asked about your relationship to the deceased, your contact information, and how you would prefer to receive the death benefit payout.

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Once the request for benefits is filed, the insurance company will process the claim. It can take some time for the company to verify you’re the beneficiary and confirm the policy didn’t lapse. Although some companies aim to pay claims in as little as 24 hours, it’s possible for a claim to take 30 to 60 days to process.

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