Life Insurance: Tax Write-Offs And Their Benefits

Life insurance premiums are generally not tax-deductible as they are considered a personal expense. However, there are specific scenarios where you might be able to claim a deduction. For instance, if you are a business owner, you can deduct life insurance premiums paid on behalf of your employees or corporate officers as long as the company is not a direct or indirect beneficiary of the policy. Additionally, if you have an alimony agreement from before 2019 that requires you to pay for life insurance on your ex-spouse, those premiums may also be deductible. Another instance where life insurance premiums can be tax-deductible is if you donate your policy to a charitable organisation.

Group term life insurance

According to the Internal Revenue Service (IRS), the first $50,000 of group term life insurance coverage provided by an employer is excluded from taxation. This means there are no tax consequences if the total amount of coverage does not exceed $50,000. However, if the coverage exceeds this amount, the imputed cost of coverage must be included in the employee's income and is subject to social security and Medicare taxes.

Giving life insurance to charity

Donating your life insurance to charity is a great way to contribute to a cause you care about and it can also offer some tax benefits. Here are some important things to know about giving life insurance to charity:

Naming a Charity as Beneficiary

One of the simplest ways to give life insurance to charity is to name a charity of your choice as the beneficiary of your life insurance policy. This allows the charity to receive the death benefit proceeds from the policy. While this doesn't offer income tax advantages, it does reduce the donor's estate by the amount of the death benefit. You can also list the charity as a revocable beneficiary, giving you flexibility if your financial situation changes. Additionally, naming a charity as a beneficiary ensures the privacy of the transaction, which can be important for donors who wish to keep their gifting intentions confidential.

Gifting Policy Dividends

Another way to donate life insurance to charity is by gifting policy dividends. Policyholders can receive dividends from their life insurance policies in cash and donate them to charity. These donated dividends are deductible in the same way as premiums paid on a gifted policy, and this strategy doesn't require any additional cash outlay from the donor.

Charitable Giving Riders

Charitable giving riders are addendums to a life insurance policy that allow you to pay a specific percentage of the policy's face value to a qualified charity. These riders usually come at no additional cost and don't reduce the death benefit. They eliminate the need to create and administer separate gift trusts. However, they often require a high amount of protection to be purchased.

Donating a Policy to Charity

You can also choose to donate an entire life insurance policy to a charity. This can be done by taking out a new policy in the name of the charitable organization or transferring ownership of an existing policy. Donating a policy provides tax benefits, as you may be able to deduct the premiums you pay from your taxes. Additionally, donating a policy allows you to make a substantial contribution through relatively small monthly or yearly payments.

Tax Implications

While donating life insurance to charity can provide tax benefits, it's important to note that the premiums paid on the policy are generally not tax-deductible. However, the death benefit paid to the charity is typically excluded from the taxable estate, which can result in significant tax savings for upper-income taxpayers.

Alimony agreements

Impact of Divorce on Life Insurance:

Divorce significantly impacts life insurance policies, especially when alimony and child support payments come into play. Courts may order individuals without coverage to purchase life insurance as part of the divorce settlement. This serves as financial protection for the recipient spouse and any minor children who depend on the higher-earning spouse's income.

Beneficiary Changes:

During a divorce, it is essential to review and update life insurance beneficiaries. Most married couples list their spouse as the primary beneficiary. However, after a divorce, individuals often want to remove their ex-spouse as the beneficiary, especially if there are no children involved. It is important to consult a lawyer before making any changes, as the terms of the divorce agreement and state laws may dictate whether the ex-spouse can be removed as a beneficiary.

Accounting for Cash Value:

In the case of permanent life insurance policies, such as whole or universal life insurance, the cash value of the policy is considered a marital asset and is subject to division during the divorce. The cash value can be divided equally between the spouses, or the policy may be cancelled, and the cash value split. It is important to review the policy details and consult with a financial professional to make informed decisions.

Protecting Alimony and Child Support:

Life insurance plays a crucial role in protecting alimony and child support payments. If the paying spouse passes away, the recipient spouse and children may be left in a financially vulnerable situation. To safeguard against this, the recipient spouse can maintain a life insurance policy on their ex-spouse, ensuring that the benefit amount is sufficient to replace the lost income until the children become financially independent.

Court-Ordered Life Insurance:

In some cases, a judge may include life insurance as part of the spousal support in the divorce settlement, especially if there are alimony or child support obligations. This is known as court-ordered life insurance, and individuals are typically given a deadline by which they must secure a policy. It is important to initiate the application process early and communicate with the ex-spouse and respective lawyers to ensure the policy meets the court's requirements.

Buying Life Insurance After Divorce:

After a divorce, individuals may need to purchase a new life insurance policy to protect their loved ones. It is recommended to buy a policy that is 10 to 15 times their income, taking into account financial obligations such as childcare, dependents, debt, income replacement, and end-of-life expenses. The type of policy, such as term or permanent life insurance, should be chosen based on individual circumstances and financial needs.

Business-paid premiums

If you're the owner of a business and you're thinking about offering life insurance as an employee benefit, you may be wondering if you can write off the premiums you pay. The good news is that, in many cases, you can indeed treat business-paid life insurance premiums as a tax-deductible expense.

When you pay premiums on a life insurance policy for your employees, the IRS typically allows you to deduct the full amount of those premiums from your business's taxable income. This can be a great way to reduce your business's tax liability while also providing valuable protection for your employees and their families.

It's important to note that there are some requirements that must be met in order to qualify for this deduction. Firstly, the life insurance policy must be owned by the business, not the individual employees. This means that the business pays the premiums and is listed as the policyowner on the policy documents. Secondly, the policy must cover a substantial number of employees, generally at least 70% of all employees, and the benefits must be available to all employees on a nondiscriminatory basis. This means that you can't just offer coverage to your top executives or favourite employees; it has to be available to everyone.

Another thing to keep in mind is that there are limits to how much coverage you can provide per employee and still qualify for the deduction. The IRS sets a dollar limit, which is adjusted annually for inflation, on the amount of coverage that can be provided tax-free to each employee. Any coverage provided above this limit is considered "excess coverage" and the premiums for that excess coverage are not tax-deductible. However, the employee can still choose to include the value of the excess coverage as taxable income on their personal tax return if they wish.

Finally, it's worth mentioning that the rules and regulations around business-paid life insurance premiums can be complex, and there may be state-specific variations that you need to take into account. As such, it's always a good idea to consult with a tax professional or insurance specialist to ensure that you're complying with all the relevant laws and that you're taking advantage of all the tax benefits to which you're entitled. By offering life insurance as an employee benefit, you can provide valuable financial protection for your employees' loved ones and enjoy tax savings for your business.

Self-employed insurance deductions

Self-employed individuals can deduct health insurance premiums for themselves, their spouses, and their dependents. This includes medical, dental, and qualifying long-term care insurance coverage. To be eligible for this deduction, the business owner must meet certain IRS guideline specifications, such as earning a net profit that is reported for the tax year on Schedule C, F, or K-1.

Self-employed health insurance deductions are applied on a month-to-month basis. You can't claim the deduction for months when you or your spouse were eligible to participate in an employer-subsidized health plan. Additionally, the deduction can't exceed the earned income collected from your business.

If you are self-employed and pay health insurance premiums for your employees, these amounts are also deductible as employee benefit program expenses.

Frequently asked questions