Life insurance offers certain non-taxable benefits under specific conditions, such as receiving dividends or taking the death benefit as a lump-sum payout. Here are details on the two primary scenarios where life insurance is tax-free:
Is Life Insurance Taxable?
In most cases, life insurance proceeds received as a beneficiary upon the insured's death are not considered taxable income and do not need to be reported. However, any interest earned on those proceeds is taxable and must be reported as interest income.
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Updated: November 12, 2025
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Key Takeaways
Life insurance payments are not taxable. In most cases, the death benefit passes to the beneficiary tax-free.
A beneficiary might have to pay taxes if a third party is the policy owner or they decide to take the death benefit in installment payments.
Your heirs could pay estate and income taxes if the life insurance payout causes the estate to exceed the federal guideline of $13.61 million.
When Is Life Insurance Not Taxable?
The death benefit is received in a lump sum
Taking the death benefit as a lump sum generally means it will be tax-free. For instance, if you are the beneficiary of a $100,000 term life insurance policy and don’t meet any of the criteria above for taxable events, you should receive the full $100,000 life insurance payout tax-free. You can do whatever you want with the lump sum, including paying for the policyholder’s funeral, paying off debt, going on vacation, investing it or giving it to charity.
You receive dividends on a permanent life insurance policy
If you have a permanent life insurance policy, you could receive dividends at the end of the year. This occurs when the insurance company ends the year with a profit after paying all its expenses. The company can share some earnings with policy owners as a dividend. Since the IRS considers dividends to be premium refunds, they are not considered taxable income.
Awareness of these nuances allows policyholders and beneficiaries to navigate their financial decisions with greater insight and efficiency, ensuring they derive the maximum life insurance tax benefits.
When Is a Life Insurance Payout Taxable?
There are some situations when life insurance is taxable. Your life insurance payout is taxable if you meet estate or gift tax criteria, receive the death benefit in installments, withdraw over the policy basis or don’t repay a cash value loan. If you surrender or sell the policy, your life insurance is taxed for the amount exceeding the policy basis. We expand more on these taxable life insurance situations below.
You receive the death benefit in installments
Taking the death benefit in installments may seem like a smart move if you’re worried about having access to a lot of cash. Still, interest on life insurance proceeds is taxable income. You may want to consult a financial advisor to help you decide how to spend, save or invest the lump sum to avoid paying income tax on the interest that accrues during the installment phase.
The death benefit causes your estate’s worth to exceed the limit
Even if your estate isn't the beneficiary of your life insurance policy, the death benefit amount is part of your net worth. For high-net-worth individuals, exceeding the federal estate tax limit means your heirs will pay estate taxes on the amount over the limit. The taxable amount is deducted from the estate assets and is not payable by the life insurance policy's beneficiaries.
There are more than two parties involved
In most cases, the insured and the life insurance policy owner are the same person. Typically, having distinct policy owners and insured individuals does not trigger a taxable event unless the beneficiary is a different person. For example, if a father owns a life insurance policy on his wife and names a child as the beneficiary, the death benefit qualifies as a gift and is subject to gift tax.
You withdraw from the policy
When you have a permanent life insurance policy, you build cash value. Once you’ve built up enough cash value, you can withdraw some funds to use however you like. Tax implications of cashing out life insurance may be triggered if the withdrawal is more than the policy basis-paid premiums minus dividends. In such cases, the difference is subject to taxes.
You fail to repay your cash value loan
You can also take a loan out from the cash value of a permanent life insurance policy. Cash value loans are tax-deferred as long as the policy stays in force. But if you fail to repay it and the policy ends, whether it lapses or you surrender it, the loan amount that exceeds the policy basis is taxable income. If you die with a loan balance, the outstanding amount reduces the death benefit proceeds your beneficiary receives.
You surrender the policy
If you no longer need or want your cash value life insurance, you can surrender it to the insurer. You’ll receive the cash value minus the surrender charge, if applicable. You won’t have to pay taxes on the cash surrender value of life insurance. You pay taxes on the life insurance cash-out investment gain, which is the amount over the policy basis.
You sell the policy
Selling a life insurance policy may subject you to both capital gains and income taxes on any profit above the policy basis.
You receive dividends
Dividends are generally not taxable when considered a return of premium. However, there are instances when dividends paid from a life insurance policy are taxable. If you leave the dividends in your policy to accumulate interest, they are not taxable, but any interest earned on those dividends is taxable.
These scenarios highlight the importance of understanding life insurance and taxes, particularly in how specific actions can change the tax implications of life insurance benefits.
IS COMPANY-PAID LIFE INSURANCE TAXABLE?
Tax implications on company-paid life insurance, often provided as a group benefit, depend on the amount of coverage. The premiums paid by the employer for coverage up to $50,000 are not taxable to the employee. If the life insurance coverage exceeds $50,000, the IRS requires the cost of the excess benefit to be reported as income, making it taxable to the employee. This is known as "imputed income" and reflects the cost of insurance the employer paid for coverage that exceeds the tax-exempt threshold. Life insurance payments are not taxable if the employee pays premiums in after-tax dollars.
Is Life Insurance Tax Deductible?
Paying premiums on life insurance is not tax deductible when you buy an individual policy. Like buying other insurance types, like home and auto, life insurance premiums are considered an ordinary life expense and, therefore, are not eligible for a tax deduction. However, some exceptions and nuances to be aware of, such as business-related life insurance expenses and accelerated death benefits, can make your life insurance premiums tax deductible.
- Business-Related Life Insurance: If you purchase a policy to protect the financial stability of a business and the business is the policy beneficiary, the life insurance payments may be tax deductible. This deduction is recognized because the insurance is deemed a necessary business expense to safeguard against financial losses that could arise from the death of a key employee or owner.
- Employer-Paid Premiums: Premiums paid by employers on life insurance policies for employees are generally deductible as a business expense. However, if the policy's coverage exceeds $50,000, the cost of the excess coverage is treated as imputed income to the employee and becomes taxable. This imputed income is considered a life insurance taxable benefit and must be reported accordingly.
- Charitable Contributions: When a life insurance policy is donated to a charity, the donor may deduct the cash surrender value of the policy at the time of donation. Subsequent life insurance payments may be tax-deductible. This arrangement not only provides a potential tax benefit to the donor but also benefits the charity upon the policyholder's death.
- Accelerated Death Benefits: Premiums paid on life insurance policies that include accelerated death benefits are deductible if the policyholder is chronically ill, and the proceeds are used to pay for significant long-term care services. These payments are typically tax-free life insurance policy payouts and help alleviate the financial burden of long-term care.
- Business Partnership Policies or Buy-Sell Agreements: The premiums of a life insurance policy might be tax deductible if you use the policy to fund buy-sell agreements. This setup ensures the business can continue smoothly by providing the funds necessary to buy out the deceased partner's interest, thereby avoiding potential financial disputes among surviving partners.
Each scenario underscores the importance of understanding the specific tax implications associated with life insurance premiums. Consider consulting with a tax professional to ensure compliance and optimization of potential tax benefits.
How to Avoid Paying Taxes on Life Insurance
There are a few ways to avoid taxes on life insurance proceeds, such as not overpaying premiums, taking a lump-sum death benefit and paying back cash value loans. We outline ways to avoid making life insurance taxable below.
- 1Get the death benefit as a lump sum
Taking a lump-sum death benefit means you avoid paying taxes on the income installment payments generated through interest. If the lump-sum payout tempts you, or you aren’t sure how to best make your money work for you, consider working with a financial advisor. You can explain your goals for the funds, and the advisor will devise a solution to meet your goals and minimize a taxable situation.
- 2Withdraw less than the policy basis
One perk of permanent life insurance is building cash value over time. Once you’ve gained a nice nest egg, you might want to withdraw funds to pay bills or take your family on vacation. You can avoid paying taxes on the withdrawn amount by taking out less than the policy basis. Your insurance company can let you know the policy basis amount so you know your withdrawal limit.
- 3Don’t overpay your premiums
Some people pay more than their premium amount to build cash value faster. But if you overpay your premiums by too much, your life insurance policy becomes a modified endowment contract, or MEC. If this happens, you pay income tax on cash value withdrawals, even if the amount is lower than your policy basis.
- 4Pay back your cash value loan
Another advantage of a cash value life insurance policy is being able to take out a loan instead of withdrawing the amount. If you take out a loan, it’s best to repay it. Not only does it accrue interest, but you could end up paying taxes on the loan amount if you fail to pay it back and the policy is canceled. Instead, work on paying back the loan as soon as you can, which can also help avoid reducing your beneficiary’s payout if you die before it’s paid back.
- 5Transfer ownership to an irrevocable life insurance trust (ILIT)
High-net-worth individuals can avoid their heirs paying taxes on life insurance by transferring the policy ownership to an irrevocable trust. Once you establish an irrevocable trust, you can’t change it. This option is a way to protect assets from creditors, estate and gift taxes. Setting up a trust can be difficult, so we recommend working with a knowledgeable financial advisor.
By implementing these strategies, policyholders can effectively manage their policies to ensure that their beneficiaries receive the maximum benefits without paying taxes on life insurance payouts.
Frequently Asked Questions About Life Insurance and Taxes
Life insurance is taxable in some situations. Find the answers to the most frequently asked questions about life insurance taxation below.
Do you pay inheritance taxes on life insurance?
Inheritance taxes on life insurance proceeds depend on state laws. Most states do not tax life insurance benefits, but six have inheritance taxes that could apply to beneficiaries. These are Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania.
Is life insurance paid out in a lump sum?
Life insurance can be paid out in a lump sum or through various installment options, depending on the policy terms and the beneficiary's choice. A lump sum is generally the default payout method.
What happens if you don’t name a beneficiary?
The life insurance proceeds usually go into the policyholder's estate if no beneficiary is named. They are distributed according to the will or state intestacy laws. This process could lead to delays and potential tax implications.
Is life insurance considered income?
Life insurance proceeds paid out as a death benefit to beneficiaries are generally not considered taxable income in the United States. This means that the money received from a life insurance policy when the insured person passes away is typically not subject to federal income tax. This applies to most life insurance policies, including term life, whole life and universal life insurance.
Are dividends from life insurance taxable?
Dividends paid from a life insurance policy are typically not taxable as they are considered a return of premiums unless they start accruing interest.
Are life insurance loans taxable?
No, life insurance loans are not taxable as long as the policy remains active. However, if the policy lapses or is surrendered, the outstanding loan amount may become taxable.
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About Mandy Sleight
Mandy Sleight is a licensed property, casualty, life and health insurance agent with 20 years of experience in the industry. She has worked for major insurance companies like State Farm and Nationwide, and most recently as the Operations Coordinator for a startup employee benefits company.
Sleight holds a business administration and management degree from the University of Baltimore and a master's in business administration from Southern New Hampshire University. She uses her vast knowledge of insurance and personal finance to create easy-to-understand and engaging content to help readers make smarter choices with their budgets and finances.
sources
- Internal Revenue Service. "Estate Tax." Accessed November 20, 2024.
- Internal Revenue Service. "Group-term Life Insurance." Accessed November 20, 2024.
- Internal Revenue Service. "Life Insurance & Disability Insurance Proceeds." Accessed November 20, 2024.
- Tax Foundation. "Facts & Figures 2024: How Does Your State Compare?." Accessed November 20, 2024.