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Life Insurance Inheritance Tax
There is a great deal of misinformation on inheritance tax on life insurance. In reality, most life insurance benefits that are paid to individuals other than in regular installments are tax free. One exception is when the beneficiary is paid more than the face value of the policy and then only the amount above the face value is taxed.
If your life insurance benefit is listed at $100,000 and you receive $100,200 then the 200 dollars is considered interest income and therefore taxed. This part and only this part (the $200) is included on your gross taxable income.
If a life insurance benefit is paid in installments then there is some tax on the life insurance beneficiary. Although it is taxable, only part of it is taxed. The way to calculate how much of your installment is tax-free is to divide the benefit by the number of years installments will be paid. That amount is the amount that is tax-free every year.
Another interesting side to life insurance benefits and taxes is estate taxes. Whereas a life insurance policy which is left to an individual is non-taxable, one that is left to the estate or the executor of the estate is taxable according to estate tax laws.
The way this works is quite simple. For example; if you name your son and daughter beneficiaries of two different life insurance policies but also buy a life insurance policy for the estate, the policies to your son and daughter respectively are not taxable but the estate policy is through the estate tax.
Some might ask why a person would buy an insurance policy and name the executor or the estate as beneficiary. The reason would be to protect a large estate from the devastating 55% federal estate tax. By adding a relatively large life insurance benefit to an already large estate the net value of the estate is protected to an extent.