Illinois Life Insurance: Payout Tax Or Tax-Exempt?

Life insurance is a crucial financial decision for families, and it is important to understand the tax implications of such policies. In Illinois, life insurance proceeds are generally not subject to federal income tax when received by the beneficiary. However, there are certain exceptions to this rule, and it is always recommended to consult with a tax professional for specific advice. While life insurance premiums are typically not tax-deductible, there is an exception when the premium is paid by an employer for the benefit of employees in a group life policy. Additionally, in Illinois, the value of group term life insurance over $50,000 is subject to both state and federal income tax and must be reported on tax returns. Understanding the tax treatment of life insurance is essential for effective financial planning and ensuring compliance with legal requirements.

Life insurance payouts are generally not taxable in Illinois

However, there are some exceptions to this rule. For example, if the policy was transferred for cash or other valuable consideration, the exclusion for the proceeds is limited to the sum of the consideration paid, additional premiums paid, and certain other amounts. Additionally, if you receive interest on the policy, this is taxable and should be reported.

It is important to note that different states have different regulations regarding taxes on life insurance policies. While Illinois does not tax life insurance payouts, other states such as Iowa, Kentucky, Nebraska, New Jersey, Maryland, and Pennsylvania enforce an inheritance tax on any inherited cash payouts, properties, and other assets.

To fully understand the tax implications of life insurance payouts in Illinois, it is recommended to speak with a tax professional or a local insurance agent. They can provide guidance and help ensure that all necessary taxes are paid and that you are compliant with the relevant regulations.

Group term life insurance over $50,000 is taxable in Illinois

Life insurance payouts are generally not taxable in Illinois or elsewhere in the United States. However, group term life insurance over $50,000 is taxable in Illinois and across the US, as per the Internal Revenue Code (IRC) and Code Section 79. This section of the code governs employer-sponsored group term life insurance plans and provides an income exclusion of up to $50,000 of employer-provided coverage. If an employee receives more than $50,000 of employer-provided group term life insurance coverage, the cost of the insurance in excess of $50,000 is included in the employee's gross income for federal income tax and Federal Insurance Contributions Act (FICA) purposes. This is true even if the employee is paying the full cost of the insurance.

The taxable portion of the premiums for coverage that exceeds $50,000 must be calculated. The imputed cost of coverage in excess of $50,000 must be included in income, using the IRS Premium Table, and is subject to social security and Medicare taxes. This is because the employer is affecting the premium cost through its subsidizing and/or redistributing role, and this benefit to employees is taxable.

It is important to note that this tax consequence arises only when the group term life insurance policy is considered "carried" by the employer. This means that the employer either pays any cost of the life insurance or arranges for the premium payments, with the premiums paid by at least one employee subsidizing those paid by at least one other employee (the "straddle" rule). If the group term life insurance policy is not considered carried by the employer, there are no tax consequences for the employee.

Additionally, it is worth mentioning that life insurance proceeds received by a beneficiary due to the death of the insured person are generally not considered taxable income. However, any interest received on the proceeds is taxable and should be reported. Furthermore, if the policy was transferred for cash or other valuable consideration, the exclusion for the proceeds may be limited, and there may be some tax consequences.

Naming a beneficiary can help avoid taxes on life insurance

Life insurance is an important part of your financial plan. It can provide financial protection for your family after you pass away and help them meet their needs. To make sure the money goes where you intend, you'll want to identify a life insurance beneficiary or multiple beneficiaries.

Naming a beneficiary is as simple as filling out the appropriate fields on your insurance contract application. You'll need to include every beneficiary's full legal name, contact information, and Social Security number (or tax ID number if your beneficiary is an organisation). This information will be used to locate and identify them, so it's important to ensure it is accurate.

While it is not mandatory to name a beneficiary, it is usually the reason people buy life insurance in the first place—to provide for the people they care about. If you don't name a beneficiary, it may be unclear who is entitled to the funds, which can delay the benefit payment. The death benefit may be paid out according to a default order of survivors stipulated in the insurance contract or to your estate. If the death benefit is paid to your estate, it will be settled during the probate court process, which can be expensive, public, and lengthy.

Therefore, naming a beneficiary can help ensure that your life insurance payout goes to the people you intend and can also help to avoid the probate process, which may result in taxes being owed.

In addition to naming a primary beneficiary, it is also important to select a contingent beneficiary. A primary beneficiary is the person or persons first in line to receive the death benefit. A contingent beneficiary will receive the death benefit if the primary beneficiary is deceased, cannot be found, or is otherwise incapable of accepting the death benefit.

It's important to keep your beneficiary designations up to date as your life changes, such as in the case of marriage, divorce, or the birth of a child. You can usually change beneficiaries at any time, although there may be some exceptions, such as if you have named irrevocable beneficiaries.

While life insurance payouts are generally not taxable, there are some instances where taxes may be owed. For example, if the cash value of the policy exceeds a certain amount, you may encounter estate taxes or generation-skipping taxes. Additionally, if you live in a state that enforces inheritance tax, such as Iowa, Kentucky, Nebraska, New Jersey, Maryland, or Pennsylvania, taxes may be owed on inherited cash payouts.

Interest on life insurance proceeds is taxable

Life insurance proceeds are generally not taxable, but there are some exceptions. In most cases, life insurance proceeds are not considered taxable income. However, any interest received on the proceeds is taxable and must be reported as such. This is true for both federal and Illinois state taxes.

If you receive life insurance proceeds as a beneficiary due to the death of the insured person, you do not need to include this in your gross income or report it. However, if the policy was transferred to you for cash or other valuable consideration, the exclusion for the proceeds may be limited, and you may need to report the taxable amount.

Additionally, if you choose to receive the life insurance payout in installments instead of a lump sum, any interest that accumulates on those payments will be taxed as regular income. On the other hand, if you cash in a policy and receive more than you put in, you will only pay income taxes on the amount above what you contributed.

It is always recommended to consult with a tax professional to ensure you are complying with all relevant laws and regulations.

Surrendering a life insurance policy may incur taxes

Surrendering a life insurance policy means cancelling your life insurance immediately. Your insurer will terminate the coverage and send you a check for the policy's cash surrender value. This is the money a life insurance policyholder receives for ending their coverage before the policy's maturity date or before they pass away, minus any surrender fees and taxes.

The cash surrender value is different from the policy's cash value, which is the total sum in the savings component of permanent policies like whole and universal life insurance. The difference arises due to surrender fees, which typically range from 10-35%. Surrender fees are usually high in the early years of the policy and then gradually phase out over time. Most policies also have a waiting period of at least 15 years before you have the option to surrender them.

When you surrender a life insurance policy, you may have to pay surrender fees for cancelling your coverage early. These fees will be deducted from any cash value your policy has or paid out of pocket if you have a term policy. You may also have to pay taxes on the surrender value if your earnings exceed the amount you've paid into the policy.

For example, if you've paid $20,000 into a policy through premiums but have a cash value of $30,000, you'll need to pay taxes on the $10,000 in earnings over what you paid in. The amount of taxes you'll pay depends on your income bracket. Assuming a rate of 22%, you'd pay $2,200 in taxes. That means your cash surrender value would be $27,200 before fees, which range from 10-35% of the policy's cash value. Assuming surrender fees are 20%, that would be another $5,440 that gets taken out, leaving you with a final cash surrender value of $21,760.

In Illinois, insurance companies are allowed to defer payment of the cash surrender value of a life insurance policy for up to six months after the application for surrender is made. However, most insurance companies pay in a timely manner. Insurance companies are not required to pay interest for cash surrender.

Before surrendering your life insurance policy, consider the following:

• The cash surrender value
• The cost of getting another life insurance policy
• Future financial goals

Frequently asked questions