Clearing Up Common Myths about Life Insurance Proceeds

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"The foundation of life insurance is the recognition of the value of a human life & the possibility of indemnification for the loss of that value." In translation, it means someone pays a premium to an insurance company for someone else to receive a a sum of money on his/ her death. The contract can also include a terminal or critical illness. Some life insurance contracts are only for a specified term. 

Many people know that having life insurance is important, however are not so sure about the proceeds that are distributed and the tax consequences of such distribution. This post seeks to clear up some of those common myths. 

The question, "Are life insurance proceeds taxable?", elicits the favorite answer of accountants worldwide, "It depends!". So what's the scoop? For federal income tax purposes, the proceeds are not taxable when received due to death of the insured. In fact, hey, they don't even get a mention on the federal income tax return! That's easy, you say?

How about the interest that has accrued on the policy? 
Like any other interest, this accrued interest is also reported. So if a beneficiary gets a check for $52,500 for the proceeds & the death benefit was $50,000 and $2,500 was interest, you report the $2,500 on Schedule B of your tax return. 

What if I receive death benefits in a lump-sum versus in installments?
That doesn't change the taxability. The benefits are not reported as income or you would not pay tax on any benefits paid due to death of the insured. The only exception to this is if the insurance proceeds are paid to you on death of a spouse, who died before October 23, 1986 and the benefits are received in installments-you can exclude $1,000 of the interest included in installments. 

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Is the right to receive life insurance proceeds a good planning tool?
Yes, it is & is used a lot in estate, trust & business planning. A life insurance policy can also be considered an asset. If the ownership is passed or sold to another party, for cash or any other kind of consideration, the proceeds paid to the beneficiary is considered taxable income to the beneficiary. 

Can this "asset" be useful to the owner of the policy as well?
Many use this as an investment device to pay for college or retirement. Income grows in the policy tax-deferred. Generally, if the policy is cashed in (or surrendered) during the lifetime of the policy holder, the proceeds are subject to tax if they are more than the investment in the policy. 

How is Investment in the policy calculated? 
The Investment = Total Premiums Paid In - Payouts in Cash from the Insurance Company. This is reported by the company to the policy holder on Form 1099-R, & it is reported on lines 16a and 16b of Form 1040. 

If a loan is taken out on a life insurance policy-if allowed under the terms of policy- the amount of the loan is not taxable. The interest paid is not tax deductible as well since the loan is a personal expense. 

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Sometimes benefits are paid out before death & the proceeds are excluded from income. These are called accelerated death benefits. These are fully excluded only if the insured has been certified by a qualified physician  as having an illness or physical condition that is expected to result in death within 24 months from the date of the certification. There are other definitions for chronically ill people who can exclude the proceeds from tax. There are certain restrictions that apply, the details for your policy should be examined. 

What does all this break down to?
Life insurance proceeds are taxable only in certain cases. However since life insurance premium is considered a personal expense, it is not deductible on your federal taxes. There are some costs that can be excluded from employer-provided insurance policies. The type of the policy, the ownership & the method by which the policy was purchased determines if the life insurance is taxable. 

Making this determination and planning for various ways in which your taxes will be affected needs consultation with a tax professional. 

Bibliography: Pub 554: Tax Guide for Seniors; The Life Insurance Buyers Guide from the NAIC. 

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website,


  1. The most important thing in getting life insurance is first to have a discussion where you'll get to learn what will be your benefits and how are you going to pay for it.
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  2. This blog gives several information about Best Term Life Insurance and their benefits. Thanks for posting this blog.


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