Life Insurance Tax In Illinois: What You Need To Know

Life insurance is a crucial financial tool that ensures your family or business can continue without you in the event of your death. While life insurance proceeds are generally not taxable, the state of Illinois imposes an estate tax on individuals who live and own property in the state, which can include life insurance proceeds if the policies were owned by the deceased. This means that if you live in Illinois, your beneficiaries may have to pay taxes on your life insurance payout. However, it's important to note that life insurance can still be an effective tool for estate planning and tax reduction, especially through the use of irrevocable life insurance trusts (ILITs). Understanding the tax implications of life insurance in Illinois is essential for comprehensive financial planning.

Life insurance proceeds are not taxed in Illinois

Life insurance is a foundation for any quality financial plan. It can be used for something as simple as a grandmother purchasing a whole life policy when a grandchild is born to use the cash value to fund college expenses. It can also be used to offset estate taxes. Life insurance policies can be used as another tool in managing personal or business risk portfolios.

Life insurance premiums are not tax-deductible. The only exception to this is when the premium is paid by an employer for the benefit of the employees in a group life policy. Cash values grow tax-deferred until received FIFO. When cash values are withdrawn, those that exceed the premium outlay are subject to ordinary income tax. Cash values are paid in addition to a death benefit—such as Option B in a universal life contract—and are considered death benefits, which are not normally subject to income tax.

If you’re a retiree living in Illinois, or just a resident who wants to protect your estate, then you might want to consider an irrevocable life insurance trust (ILIT). This type of trust allows you to shelter your estate from a heavy tax burden so you can ensure your legacy lives on.

Excessive cash value may be charged income tax

Life insurance is an important financial tool that ensures your family or business can continue without you in the event of your death. While the proceeds from life insurance are generally not taxable, there are certain situations where taxes may come into play. In Illinois, as in every other state, life insurance proceeds are not taxable to the beneficiary for income tax. This means that the death benefit your loved ones receive is typically tax-free.

However, it's important to note that the cash value of a life insurance policy may be subject to taxation if it is excessive. The cash value of a life insurance policy refers to the amount of money that accumulates within the policy over time, and it is typically associated with permanent life insurance policies such as whole life or universal life. While the cash value can be accessed during the lifetime of the insured, it is important to understand the tax implications before making any withdrawals.

In Illinois, the only portion of a life insurance policy that may be subject to income tax is the excessive cash value. This means that if the cash value of your policy exceeds a certain threshold, the beneficiary may be required to pay income tax on the excess amount. The specific threshold or limit for excessive cash value can vary and depends on the specific tax laws and regulations in Illinois. Therefore, it is always recommended to consult with a tax professional or financial advisor to understand the current rules and how they apply to your specific policy.

Additionally, it's important to consider estate taxes when discussing life insurance in Illinois. Illinois is one of the states that imposes a death tax, which is charged on individuals who live in the state or own property or assets physically located within its borders. The estate tax threshold in Illinois is currently set at $4 million, and the tax rates can go as high as 16%. When planning your estate, it is crucial to take into account the value of your life insurance policies, as they may be included in your taxable estate. By working with a qualified professional, you can explore strategies such as irrevocable life insurance trusts (ILITs) to help minimize the tax burden on your heirs.

Estate taxes may need to be paid from proceeds

Estate Taxes and Life Insurance Proceeds

In Illinois, while life insurance proceeds are generally income-tax-free for the beneficiary, they may be subject to estate taxes under certain circumstances. Estate taxes are levied on the transfer of property, including life insurance policies, from the deceased person's estate to their heirs or beneficiaries.

The estate tax is applicable when the deceased person's estate exceeds a certain value. In Illinois, the estate tax exemption is currently aligned with the federal estate tax exemption, which is $12.06 million for deaths in 2023. This means that estates valued below this threshold are typically exempt from paying estate taxes.

However, if the deceased's estate, including the life insurance policy proceeds, exceeds the exemption amount, estate taxes may need to be paid. The tax is calculated based on the value of the estate above the exemption threshold. It is important to note that the estate tax is typically paid by the estate itself, not directly by the beneficiaries, although the impact of the tax will, of course, reduce the amount that beneficiaries receive.

To illustrate with an example, consider an estate valued at $13 million, including a life insurance policy worth $2 million. In this case, the estate exceeds the exemption threshold, and estate taxes would likely be owed. The tax would be calculated on the difference between the estate's value and the exemption amount, which is $1 million in this instance ($13 million minus the $12.06 million exemption). The applicable tax rates and specific calculations can be complex and depend on various factors, so it is advisable to consult with a tax professional or financial advisor familiar with Illinois estate tax laws.

To ensure compliance with tax laws and to make the necessary arrangements, it is important for individuals with substantial assets, including life insurance policies, to seek professional advice and carefully plan their estates. This may involve strategies such as establishing trusts, making charitable donations, or taking advantage of available exemptions and deductions to minimize potential estate tax liabilities.

Death proceeds are not subject to federal income tax

In Illinois, life insurance proceeds are not taxed and are directed to the named beneficiary. However, the state has a death tax, and life insurance proceeds are considered part of an individual's estate if the policies were owned by the deceased. This means that estate taxes may need to be paid from the proceeds if the estate is large enough.

Death proceeds, in general, are not subject to federal income tax when received by the beneficiary. This means that the death benefit amount or type of policy contract, such as term, whole, or universal life insurance, is not taxable. The only portion of life insurance that may be charged income tax is excessive cash value.

It is important to note that there are minor exceptions to this rule, so it is recommended to consult with a licensed professional, a life insurance agent, or a tax advisor to discuss specific situations. Life insurance can be a valuable tool in estate planning and managing personal or business risk portfolios.

Additionally, life insurance premiums are not tax-deductible, except when paid by an employer for the benefit of employees in a group life policy. Cash values grow tax-deferred until received, and when cash values are withdrawn, those that exceed the premium outlay are subject to ordinary income tax. However, cash values paid in addition to a death benefit are typically not subject to income tax.

Life insurance premiums are not tax-deductible

Life insurance proceeds are not taxed. They are directed to the named beneficiary. However, estate taxes may need to be paid from the proceeds if there is a very large estate. This is why it is recommended that Illinois residents, especially retirees, come up with an estate plan in advance. An irrevocable life insurance trust (ILIT) can help shelter an estate from a heavy tax burden.

Life insurance policies in a trust are not considered part of your estate. By transferring your wealth into an ILIT, you reduce your overall taxable estate, which may put you in a lower estate tax bracket or eliminate estate tax entirely. ILITs can also manage the inheritances of several beneficiaries at once, allowing you to secure your entire family's future from one pool of funding.

It is worth noting that there are some exceptions to the rule that life insurance is not taxable. Speaking to a life insurance agent or tax advisor can help clarify these exceptions.

Frequently asked questions