Understanding Taxable Benefits For Life Insurance

Life insurance is typically not taxable, but there are some exceptions. The taxability of life insurance proceeds depends on the type of policy, the size of the estate, and how the benefit is paid out.

Beneficiaries

Beneficiaries generally don't pay taxes on the life insurance death benefit, especially if they receive it as a lump sum. However, if the beneficiary chooses to receive the payout as an annuity, they will be responsible for paying income taxes on any interest accrued.

Estate Taxes

The death benefit is usually paid directly to the beneficiaries. However, if it is included in the estate, it may be subject to federal and state estate taxes if the value exceeds the tax exemption amount. The federal exemption is currently $12.92 million for a single person and nearly $26 million for a married couple.

Policy Riders

Policy riders are optional features that can be added to a life insurance policy to cover life events that a standard policy does not. These riders are typically not subject to taxes but would reduce the amount that the beneficiary receives.

Taxable Gifts

A life insurance death benefit would be subject to taxes in the event of a taxable gift, which occurs when the policyholder, insured, and beneficiary are three different people. In this case, the policyholder may have to pay gift taxes for any benefit amount that exceeds federal gift tax exemption limits.

Calculating taxable benefit for life insurance for employees

Life insurance is typically not taxable, but there are some exceptions. Here is a guide on calculating taxable benefits for life insurance for employees.

Group-term life insurance

The IRS provides an exclusion for the first $50,000 of group-term life insurance coverage provided under a policy carried directly or indirectly by an employer. There are no tax consequences if the total amount of such policies does not exceed $50,000. The imputed cost of coverage in excess of $50,000 must be included in income and is subject to Social Security and Medicare taxes.

Carried directly or indirectly by the employer

A taxable fringe benefit arises if coverage exceeds $50,000 and the policy is considered carried directly or indirectly by the employer. This occurs when:

• The employer pays any cost of the life insurance.
• The employer arranges for the premium payments, and the premiums paid by at least one employee subsidize those paid by at least one other employee (the "straddle" rule).

Not carried directly or indirectly by the employer

A policy that is not considered carried directly or indirectly by the employer has no tax consequences for the employee.

Coverage for spouse and dependents

The cost of employer-provided group-term life insurance on the life of an employee’s spouse or dependent is not taxable to the employee if the face amount of the coverage does not exceed $2,000. This coverage is excluded as a de minimis fringe benefit.

If the life insurance policy goes into an estate

If the policy doesn't have any named beneficiaries, the life insurance proceeds may be included in the deceased's estate. If the value of the estate exceeds the federal estate tax threshold, which was $13.61 million as of 2024, estate taxes must be paid on the amount that's over the limit. Some states also assess inheritance or estate taxes.

You choose to receive the death benefit as an annuity

If a beneficiary chooses to receive their payout as an annuity (a series of payments over several years) instead of a lump sum, any interest accrued by the annuity account may be subject to taxes.

You withdraw or take out a loan against your whole life policy's cash value

If you withdraw more than your cumulative premium payments, you may have to pay income taxes on the excess. Likewise, if you borrow against the cash value and the loan is still outstanding when the policy is terminated or surrendered, the loan amount in excess of the cumulative premiums may be subject to income taxes.

You surrender your whole life insurance policy

If you surrender the policy and your surrender proceeds exceed the cumulative premiums, the excess may be subject to income taxes.

You sell your whole life policy

If you sell your policy to a third party, and the sales proceeds exceed your cumulative premiums, the excess may be subject to income taxes.

Types of taxes on life insurance

Inheritance or estate taxes

Beneficiaries may have to pay inheritance or estate taxes if the policy is part of the deceased's estate, and the value of the estate exceeds the state or federal estate tax threshold.

Beneficiaries may have to pay income taxes

Beneficiaries may have to pay income taxes if they elect to receive the policy's death benefit as an annuity, since the interest accrued in the annuity account is considered taxable income.

If you own a whole life policy, you may owe income tax

If you own a whole life policy, you may owe income tax if you sell or surrender your policy, or if you withdraw or borrow against your policy's cash value.

According to the IRS, if you have less than $50,000 in coverage through your employer, you won't be responsible for paying taxes on the value of the coverage. But if the death benefit is greater than $50,000, the employer-paid premiums for coverage over $50,000 are subject to income taxes.

Taxable benefit for life insurance with no named beneficiaries

When a life insurance policy has no named beneficiaries, the death benefit typically goes to the policyholder's estate and through probate. Probate is a legal process that includes authenticating the deceased's will and distributing their property under court supervision. This process can be lengthy and may delay the distribution of funds to the deceased's loved ones.

In the United States, if the total amount of group-term life insurance coverage provided by an employer exceeds $50,000, the imputed cost of coverage must be included in the employee's income and is subject to Social Security and Medicare taxes. This is considered a taxable fringe benefit. However, if the coverage is $50,000 or less, there are no tax consequences.

In Canada, employer-paid premiums for group term life insurance policies are considered a taxable benefit for current, former, and retired employees. The benefit amount is calculated based on the premiums payable for term insurance on the individual's life, sales and excise taxes, any provincial insurance levies or sales tax, and the premiums and taxes paid by the employee.

Taxable benefit for life insurance proceeds paid as an annuity

In the United States, life insurance proceeds paid as an annuity are generally not taxable if received as a beneficiary due to the death of the insured person. However, if the policy was transferred to the beneficiary for cash or other valuable consideration, the exclusion for the proceeds may be limited, and there may be some exceptions to this rule. Any interest received on the payout is taxable and should be reported.

In Canada, the taxable benefit for life insurance proceeds paid as an annuity is calculated based on the premiums paid, taxes, and any reimbursements made by the employee. The benefit is generally considered to be the total of the following:

• Premiums payable for term insurance on the individual's life
• Total sales taxes and excise taxes (excluding GST/HST) applicable to the individual's insurance coverage
• Any provincial insurance levies or sales tax that employers are required to pay on insurance premiums
• Premiums and any taxes paid by the employee, either directly or through reimbursements

If the premiums are paid regularly and the premium rate does not depend on age or gender, the above calculation can be used. Otherwise, a detailed calculation is required.

Taxable benefit for life insurance proceeds paid as a loan

Life insurance proceeds paid upon the insured's death are generally not taxable. However, there are some exceptions to this rule.

Loans from Life Insurance Plans

If you take out a loan from your life insurance plan, the loan won't be taxable unless the policy terminates before you've repaid the loan. In this case, you may be taxed on the outstanding loan amount.

Taxation of Group-Term Life Insurance

The Internal Revenue Service (IRS) in the US provides an exclusion for the first $50,000 of group-term life insurance coverage provided under a policy carried directly or indirectly by an employer. If the total amount of coverage exceeds $50,000, the imputed cost of coverage must be included in the employee's income and is subject to taxation.

The determination of whether the premium charges are carried directly or indirectly by the employer depends on whether the employer pays any cost of the insurance or arranges for the premium payments, resulting in some employees subsidising the costs of others. This is known as the "straddle" rule.

If the total amount of coverage is provided by more than one insurer, each policy must be tested separately to determine tax liability unless costs and coverage can be clearly allocated between the two policies.

Taxation of Life Insurance Proceeds as Loans

In Canada, loans received because of employment are generally taxable. The benefit is calculated as the amount of interest that the person would have paid on the loan for the year, minus any interest that they paid on the loan within the same year or up to 30 days after the end of the year.

Taxation of Interest on Life Insurance Proceeds

Interest earned on life insurance proceeds is generally taxable.

Taxable benefit for life insurance proceeds paid as a lump sum

In the United States, life insurance proceeds are generally not taxable if received as a beneficiary due to the death of the insured person. However, if the policy was transferred to the beneficiary 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. Any interest received on the proceeds is also taxable.

In Canada, the rules for calculating taxable benefits for group term life insurance premiums paid by employers are outlined in the "Employers' Guide – Taxable Benefits and Allowances." The benefit amount depends on whether premiums are paid regularly and if the premium rate for each individual is dependent on age or gender. If premiums are paid regularly and the rate is the same for all individuals, the benefit is calculated as:

• The premiums payable for term insurance on the individual's life
• The total of all sales taxes and excise taxes, excluding GST/HST, that apply to the individual's insurance coverage
• Any provincial insurance levies or sales tax (8% for Ontario, 7% for Manitoba, and 9% for Quebec) that employers have to pay on insurance premiums
• The premiums and any taxes the employee paid either directly or through reimbursements

If the above conditions are not met, a detailed calculation is required.

In the US, group-term life insurance coverage provided by an employer may be excluded from taxation up to $50,000. If the total amount of coverage exceeds this limit, the imputed cost of coverage must be included in the employee's income and is subject to Social Security and Medicare taxes. This taxable portion is calculated using the IRS Premium Table. If the coverage is not considered carried directly or indirectly by the employer, there are no tax consequences for the employee.

Frequently asked questions