Tax On Life Insurance Payouts

A payout on a life insurance refers to the amounts received under a life insurance contract due to death of the insured person. The insurance company gives an option to the beneficiary to choose the mode he wants to receive the payout. These options include lump-sum payment of the entire death benefit at a go, as a guaranteed income over the remainder of his life, as life income with period certain etc. The beneficiary can opt for any of these or other available options for payout of the death benefit.

People are always concerned about the tax they are subjected to in case of any type of income. For life insurance beneficiaries, the good news is that the death benefit under a life insurance contract because of the death of the insured person is not included in gross income and hence comes tax free to the beneficiary. However, there are certain conditions that may require one to pay some tax on life insurance proceedings.

Though the amount of the insurance cover that a beneficiary receives as a payout is tax free, the interest gained on this amount is taxable and needs to be presented as an income, much like any other interest one receives. Also, in cases where there is no beneficiary, the death benefit proceeds of the life insurance policy are subjected for inclusion in the estate of the policy owner, and may be subject to state, federal and inheritance taxes.

Apart from the discussed cases, there are several other factors that can make the income tax proceeds to the beneficiary taxable. One very often overlooked factor is where there has been a transfer for value, which means if the policy was transferred to the beneficiary for cash or other valuable considerations. In such cases, the tax inclusion is only limited to the sum of the consideration the policy receiving party paid, any additional premiums paid, and certain other amounts.

A beneficiary of life insurance may need to pay some taxes depending upon the mode of payout chosen. If the payouts are not received in installments, the benefits that are more than the amount payable to the beneficiary at the time of the insured person's death are taxable. However, if one choses to receive the payouts in installments, each such installment can be excluded from one's income. For example, if the face amount of the policy happens to be $75,000 and the beneficiary chooses to receive 120 monthly installments of $1,000 each, $625 ($75,000 � 120) is excluded from each installment, while the rest of each installment i.e. $375 per month being interest income, is subjected to taxes.

There can be another case where one may need to pay tax on life insurance proceeds. If the policy happens to be an employer-owned life insurance contract, only the amount paid by the insured in the form of premiums or any other amounts paid on the policy are tax free and any life insurance proceeds received excluding these amounts need to be included in the beneficiary's income and is subjected to taxes. There is one more case, one needs to pay tax on life insurance surrender, if one surrenders a life insurance policy for cash, any amount which is more than the cost of the life insurance policy is taxable.