Life Insurance And Irs: Can They Garnish Your Policy?

The Internal Revenue Service (IRS) is the US's largest and most powerful creditor, with the authority to garnish wages, seize savings, take property, and seize assets when citizens owe back taxes or fines. While the IRS can place liens and levies on income and property, there are some assets that are untouchable and exempt from seizure, including life insurance.

Life insurance is often used as a financial planning tool to provide for one's family in the event of unforeseen circumstances, and state and federal agencies have set limits on the rights of creditors to insurance. However, the federal government can collect unpaid income taxes from life insurance policies, as well as disability payments, annuity contracts, and more.

Can the IRS seize life insurance benefits?

The IRS can be a formidable force when it comes to seizing assets, but there are limits to its powers. While it can garnish wages, deplete savings accounts, seize property, and even take assets when you owe back taxes or fines, there are some protections in place for certain assets, including life insurance.

Life insurance benefits are generally considered untouchable by the IRS, and they cannot be seized before a claims payout. When a life insurance claim is made, the proceeds are paid directly to the beneficiary, bypassing the benefactor's estate. This means that creditors, including the IRS, cannot claim this money, and it is protected from being used to pay off the benefactor's debts.

However, there are some scenarios where the IRS can stake a claim on life insurance proceeds. If the benefactor owes taxes or has fines and penalties, the IRS may attempt to collect from the estate before probate is settled. While they cannot directly seize the life insurance proceeds, they can seize property and vehicles from the estate, delaying any inheritance payouts until they receive what they are owed.

Additionally, if the beneficiary is also the spouse of the deceased and they file joint tax returns, the IRS can place a levy on the life insurance proceeds to collect unpaid taxes. The IRS can also claim proceeds if there is joint debt, such as a co-signed mortgage or car loan, where the contract allows the lender to collect the remaining balance from one party in the event of the other's death.

Furthermore, while the IRS cannot seize proceeds paid to a named beneficiary if state law exempts such proceeds from creditors, they can still collect taxes from a beneficiary spouse if they file a joint return for the period of deficiency.

It is important to note that while life insurance proceeds are generally not taxable, they are considered part of a taxable estate. This means that if the benefits push the estate's value over the taxable threshold, estate taxes will be charged, and heirs will not receive their inheritance until these taxes are paid in full.

To protect life insurance benefits from the IRS, it is recommended to name multiple beneficiaries, not just a spouse, and to consider naming a trust as the beneficiary, as this offers greater protection against creditors.

What if there's a beneficiary listed on the policy?

If there is a beneficiary listed on the policy, the IRS cannot forcefully collect the proceeds. This is because the proceeds are paid directly to the beneficiary and do not become part of the benefactor's estate. However, there are certain scenarios where the IRS can still stake a claim on the proceeds.

Firstly, if the beneficiary owes back taxes, the IRS can place a lien on their assets, including the insurance proceeds. The IRS can also claim the proceeds if the beneficiary is the executor of the estate and the estate owes taxes. In this case, the executor may be required to use the insurance money to pay off the estate's tax debt.

Additionally, if the beneficiary receives the proceeds as an annuity, any interest accrued becomes taxable income. Similarly, if the policy is surrendered before the insured person's death, the amount exceeding the total premiums paid becomes taxable.

It is important to note that proper estate planning can help protect life insurance proceeds from potential IRS claims. Creating a life insurance trust, for example, can shield the proceeds from estate taxes and creditor claims. Seeking guidance from financial advisors and tax experts is also invaluable in ensuring that beneficiaries receive the maximum benefit from life insurance proceeds.

What if the beneficiary owes taxes or has fines?

If the beneficiary owes taxes or has fines, the IRS can seize the life insurance benefits. While the IRS generally cannot seize life insurance benefits, they can do so if there is no named beneficiary or if the beneficiary is under the age of 18.

In the case of unpaid taxes or other debts, the IRS can also seize the benefits if they are not paid off by the policyholder or beneficiaries. This is because the life insurance proceeds become part of the beneficiary's assets, and the IRS can take what is owed from these assets. Therefore, it is important to review your tax situation and resolve any issues before receiving the proceeds. If there is an agreement in place to make payments, the IRS's power to seize funds is limited as long as the agreement is being adhered to.

To prevent the seizure of benefits, it is recommended to name multiple beneficiaries, rather than just a spouse, and to address any potential issues while the policyholder is still living. Additionally, naming a trust as the beneficiary can provide more protection and help minimise estate tax liabilities. However, this should be discussed with a financial advisor first.

What if the owner of the policy owes taxes?

If the owner of the policy owes taxes, the IRS can take the life insurance proceeds. The Internal Revenue Code imposes a tax lien on all property and rights to property, including cash values of insurance policies, which are not exempt. This means that the government will take money from the life insurance policy if the insured owes taxes.

The lien can be attached to properties that are not accessible to private creditors and state exemption laws do not apply. A lien on the policy will be carried on past the insured individual’s death. However, the lien is unable to reach cash values of partnership-owned insurance policies.

The IRS can also force someone to sell their policy and then take the proceeds to pay off the tax claim. This is because government liens apply to any and all policy-owner taxpayer rights, including policies that do not have a cash surrender value.

If the owner of the policy has an automatic premium loan, the IRS recognises that the government’s lien is invalid against an insurance company’s policy loan if it was granted before there was an actual notice of the lien, or after actual notice, if there is a contractual requirement for the automatic premium loan.

The government also has rights to disability and annuity payments. The government is able to claim all monthly income disability payments due to the uninsured taxpayer to cover any unpaid taxes. This is recognised under the Social Security Act, in which disability benefits are also subject to government claims for any unpaid income taxes. The government is also able to enforce a lien against a taxpayer’s annuity contracts.

What if the beneficiary is the deceased's spouse?

If the beneficiary is the deceased's spouse, the IRS can still seize the life insurance benefits if the government has a lien for income tax deficiencies. This is only valid against the cash surrender value of the taxpayer's insurance policies. However, if the state laws exempt the insurance proceeds from creditors' claims, the IRS cannot seize the benefits.

State laws will not prevent the IRS from obtaining the tax from a beneficiary spouse if they and the deceased spouse file a joint return for the period of deficiency. When a joint tax return is filed, both a joint and separate liability is imposed on the husband and wife.

The IRS will not have a lien if, after the taxpayer's death, the government determines that a tax deficiency exists. There will also be no resource if, under IRC Section 6901, against life insurance proceeds payable to named beneficiaries if state law exempts such proceeds from creditors.

Usually, state law will not exempt life insurance proceeds from creditors if proceeds are payable to the deceased person's estate, an administrator, or a trust for the benefit of the estate, such as a beneficiary who has agreed to use the proceeds for the estate's benefit.

A government claim against the estate will usually be a much higher priority than that of unsecured creditors.

Frequently asked questions