When someone passes away, their loved ones may receive a payout from their life insurance policy. This money can be a critical source of financial support during a difficult time, but many people wonder if they will have to pay taxes on this money. In this article, we will explore whether life insurance payouts are taxable.
In general, life insurance payouts are not taxable. This means that the beneficiary of the life insurance policy will not have to pay federal income tax on the money they receive from the policy. This is true regardless of the amount of the payout and regardless of the type of life insurance policy.
There are a few exceptions to this general rule, however. If the policyholder had borrowed against the policy, the amount of the loan will be subtracted from the death benefit before it is paid out to the beneficiary. In this case, the beneficiary will only receive the remaining amount of the death benefit, and they will not have to pay taxes on the portion of the death benefit that was used to pay off the loan.
Another exception is if the policyholder has a modified endowment contract (MEC). A MEC is a type of life insurance policy that has been over-funded, which means that the policyholder has paid more in premiums than is allowed under federal tax law. If the death benefit is paid out to the beneficiary of a MEC, the money may be subject to taxes.
In addition, if the beneficiary of the life insurance policy chooses to receive the death benefit as a series of payments rather than a lump sum, they may be subject to taxes on the interest earned on the money.
It is also worth noting that while life insurance payouts are generally not subject to federal income tax, they may be subject to estate tax if the policyholder’s estate exceeds certain thresholds. However, the vast majority of people do not have to worry about estate tax.
In conclusion, life insurance payouts are generally not taxable. This means that the beneficiary of the life insurance policy will not have to pay federal income tax on the money they receive from the policy. There are some exceptions to this rule, however, and it is important to be aware of these exceptions and to consult with a tax professional if you have any questions about your specific situation.
