Life Insurance Money: Taxable Income In Connecticut?

Life insurance provides financial security for your loved ones after you pass away. But what about the tax implications? In Connecticut, beneficiaries generally don't have to worry about paying taxes on the payout from a term, whole, or universal life insurance policy, as it isn't considered part of their gross income. However, there are certain situations where the beneficiary may be taxed on some or all of the proceeds. For example, if the payout is structured as multiple payments over time, the interest accrued during that period may be taxable. Similarly, if the policyholder named an estate as the beneficiary, the value of the insurance proceeds may be included in the deceased's estate, and estate taxes may apply if it exceeds the federal estate tax threshold. Additionally, if the policyholder withdraws money or takes out a loan against the policy, exceeding the total amount of premiums paid, the excess may be subject to taxation. Understanding the tax implications of life insurance payouts is crucial for financial planning, and consulting with a tax professional is always advisable.

Interest on instalments

In Connecticut, life insurance money is generally not taxable if you are the beneficiary of the policy. However, there are certain situations in which the proceeds from a life insurance policy are taxable. One such situation is when the beneficiary receives the payout in installments. While the principal death benefit remains untaxed, any interest that accrues on the installments is considered taxable income.

When receiving a life insurance payout in installments, it is important to understand the tax implications. The interest that accrues on the installments is subject to taxation. This means that the beneficiary will be required to pay taxes on the interest portion of the payout. It is essential to consult with a tax professional or financial advisor to ensure compliance with tax laws and to make informed decisions regarding the life insurance proceeds.

Additionally, it is worth noting that the tax treatment of life insurance proceeds can vary depending on the specific circumstances and the type of policy involved. For example, if the beneficiary of the life insurance policy is an estate, the death benefit may be subject to estate taxes. In such cases, the federal estate tax rates and exemption limits apply, and there may also be state-level estate or inheritance taxes to consider.

Furthermore, the tax consequences of withdrawing money from the cash value of a life insurance policy should be considered. Both whole life and universal life insurance policies accumulate cash value over time, and if the withdrawal exceeds the total amount of premiums paid, the excess amount may be subject to taxation. It is important to carefully review the terms of the life insurance policy and seek professional advice to understand the potential tax implications of any withdrawals or loans against the policy's cash value.

Understanding the tax implications of life insurance proceeds is crucial for effective financial planning. While the death benefit is typically tax-free, there are specific circumstances, such as installment payments, estate beneficiaries, and withdrawals from cash value, that can trigger tax liabilities. By staying informed and seeking professional guidance, individuals can make well-informed decisions regarding their life insurance policies and associated tax obligations.

Pre-tax or post-tax money

In general, life insurance proceeds are not considered taxable income in Connecticut or any other state in the US. If you are the beneficiary of a life insurance policy, the payout—known as a death benefit—is typically tax-free and not considered part of your gross income. This applies to term, whole, or universal life insurance policies.

However, there are some exceptions where the death benefit can be taxed. Here are some scenarios where life insurance proceeds may be taxable:

• Payout structure: If the payout is structured as multiple payments over time, these payments can be subject to taxes. This includes annuities, which are paid regularly over the life of the beneficiary and include proceeds plus interest.
• Withdrawing cash value: Whole life and universal life insurance policies earn interest, referred to as cash value, and policyholders may withdraw or take out loans against this balance. If the withdrawal or loan amount exceeds the total amount of premiums paid, the excess may be taxed.
• Surrendering the policy: If you cancel a whole or universal life insurance policy, you typically receive the cash surrender value, which is the policy's cash value minus any fees. While you don't pay taxes on the principal amount, any cash value accrued will be taxed as income.
• Employer-paid group life insurance: If you are receiving proceeds from an employer-paid life insurance policy, any death benefit beyond $50,000 may be taxed as income, according to the IRS.
• Beneficiary is an estate: If the beneficiary of the life insurance policy is an estate rather than an individual, the death benefit may be subject to estate taxes. In 2024, the federal estate tax ranges from 18% to 40% for estates valued over $13.61 million.
• Payment in installments: If the policy payout is received in installments rather than a lump sum, any interest that accrues during this time may be taxable, although the principal death benefit remains untaxed.

To summarise, while life insurance proceeds are generally not considered taxable income, certain circumstances can trigger tax liability. These include situations where interest is accrued or when the proceeds are included as part of a taxable estate. Therefore, it is essential to understand the specific conditions that may apply to your life insurance policy and consult with a tax professional or financial advisor to ensure compliance with tax regulations.

Estate taxes

The Connecticut estate tax is separate from the federal estate tax, and the two are not mutually exclusive. If an estate is large enough, it may be required to pay both state and federal estate taxes. The Connecticut estate tax rate is currently a flat rate of 12%, whereas the federal rate is 40%.

The estate tax is the responsibility of the executor of the will to calculate and pay, and they may require the help of a lawyer or accountant to do so accurately. The deadline for filing the Connecticut estate tax return is six months after the death.

It is important to note that the estate tax is different from inheritance tax, which is a tax levied on money or assets received from the estate of a deceased person.

Withdrawing money from cash value

Withdrawing money from the cash value of your life insurance policy is a great way to supplement your income, but there are a few things you should know before doing so.

Firstly, it's important to understand the difference between term life and permanent life insurance. Term life insurance is typically less expensive and provides coverage for a predetermined amount of time, usually a "term" of one to thirty years. On the other hand, permanent life insurance provides coverage for your entire life and can build cash value, which can be used to supplement retirement income or cover large purchases. Whole life and universal life are the two primary types of permanent life insurance. While both offer coverage for life and build cash value, whole life insurance offers more guarantees and a fixed interest rate, whereas universal life insurance offers more flexibility.

Now, let's discuss the process of withdrawing money from the cash value of your life insurance policy. There are a few different ways to access the cash value:

• Withdrawal: You can simply withdraw money from the cash value, usually up to the amount you've paid in premiums without paying taxes on the funds. However, withdrawals will reduce your death benefit, and if you withdraw more than the total amount of premiums paid, you may have to pay taxes on the excess.
• Loan: You can take out a loan against the cash value of your policy, which typically comes with a lower interest rate than a personal loan and does not require a credit check. You can choose not to repay the loan, but the outstanding balance will be deducted from your death benefit.
• Surrender: If you no longer need your life insurance policy, you can surrender it and receive the cash surrender value, which is the policy's cash value minus any fees. However, this will result in the cancellation of your policy, and you will no longer have life insurance coverage. Additionally, any cash value accrued will be taxed as income.
• Use cash value to pay premiums: If you want to keep your coverage in place, you can use the cash value to pay your life insurance premiums.

It's important to carefully consider the pros and cons of each option before making a decision. Withdrawing or taking out a loan against the cash value of your life insurance policy can provide you with much-needed funds, but it will also reduce your death benefit. Surrendering your policy will result in the loss of coverage, and you will have to pay taxes on any accrued cash value. Using the cash value to pay your premiums can help reduce your monthly expenses while maintaining your coverage.

Surrendering the policy

Surrendering a life insurance policy means essentially cancelling it. This is a common option for whole life insurance policies, which accrue cash value over time. By surrendering, you agree to take the cash surrender value while also forgoing the death benefit. You can surrender your policy at any time, but the age of your policy will affect the money you receive. Generally, the longer you've had the policy, the more you'll get.

Many insurance companies have a "surrender period" during the first few years, during which you may get no money if you cancel. Some insurers may also impose steep penalties for early cancellation to recoup the costs of setting up the policy. Therefore, it's important to check with your insurer about the costs of cancelling. In general, the earlier you cancel, the steeper the fees.

If you decide to surrender your policy, the first step is to contact your insurance company. You may be able to write a letter of intent, or the company may require you to fill out a surrender form. Once your insurer processes the request, you should receive the cash surrender value for your policy.

It's important to note that some of the funds you receive may be subject to being taxed as income. The money you originally paid in won't be taxed, but anything you receive over that amount will be taxable.

There are several reasons why someone might choose to surrender their life insurance policy:

• They no longer need the coverage (e.g. their beneficiary passed away, they're getting divorced, or their children are adults)
• They have improved their health and now have access to cheaper options
• They want or need to access the money for other purposes, such as an emergency expense or a more lucrative investment opportunity
• The premiums are too expensive
• The policy no longer meets their needs

Frequently asked questions