Orlando Harmon
Life insurance policies can be subject to income and capital gains taxes. If you sell your policy for more than you've paid in premiums, the gain on that amount could be taxed. This also applies to the new owner of the policy, who may face taxes on any death benefit they receive that exceeds what they paid for the policy, plus any premiums they've continued to pay. In addition, dividends are taxed as a distribution of income first for a MEC policy, unless they are retained by the insurer as premiums or other considerations for the policy. Loans, pledges, and collateral assignments of a MEC are also treated as distributions and are therefore taxable to the extent of gain.
| Characteristics | Values |
|---|---|
| If you sell your policy for more than what you've paid in premiums | The gain on that amount could be taxed |
| If you own a term life insurance policy when you pass away | The death benefit becomes part of your taxable estate |
| If the death benefit exceeds what the new owner of the policy paid for the policy, plus any premiums they've continued to pay | The new owner of the policy may face taxes on the death benefit |
| If the total value of your estate exceeds the federal estate tax exemption ($13.99 million in 2025) | Your estate could be subject to estate taxes |
| If you have a MEC policy | Dividends are taxed as a distribution of income first unless they are retained by the insurer as premiums or other considerations for the policy |
| If you take out a loan against a MEC policy | Any gains up to the amount of the loan will be recognised and taxed |
| If you eliminate a policy loan during a 1035 exchange | The loan is taxable to the extent of any gain in the policy at the time of the exchange |
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What You'll Learn
Selling your policy for more than you've paid in premiums
If you sell your life insurance policy for more than you've paid in premiums, the gain on that amount could be taxed. This is because the new owner of the policy may face taxes on any death benefit they receive that exceeds what they paid for the policy, plus any premiums they've continued to pay.
If you own a term life insurance policy when you pass away, the death benefit becomes part of your taxable estate. This could push your estate's total value above the federal estate tax exemption, triggering estate taxes. While this generally impacts only high-net-worth individuals, some states have a state estate tax as well, which is typically a lower threshold, so it's important to factor that into your planning.
Dividends are taxed as a distribution of income first for a MEC policy unless they are retained by the insurer as premiums or other considerations for the policy. Dividends held to accumulate at interest, or retained to repay loan principal or interest, are considered MEC distributions.
MECs must still meet the definition of life insurance, so cash value accumulations on a MEC are generally not subject to current tax if not withdrawn. However, if a MEC is pledged as collateral for a loan or a policy loan is taken, then any gains up to the amount of the loan or pledge will be recognised. Distributions from a MEC are taxed as earnings first, followed by a return of the policy's cost basis. Therefore, distributions are taxable to the extent of gain. For this purpose, loans, pledges, and collateral assignments of a MEC are treated as distributions.
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Capital tax gains
If you sell your life insurance policy for more than what you've paid in premiums, the gain on that amount could be taxed. This is because any amount above the cash value is subject to capital tax gains. The new owner of the policy may face taxes on any death benefit they receive that exceeds what they paid for the policy, plus any premiums they've continued to pay.
If you own a term life insurance policy when you pass away, the death benefit becomes part of your taxable estate. This could push your estate's total value above the federal estate tax exemption, triggering estate taxes. While this generally impacts only high-net-worth individuals, some states have a state estate tax as well, which is typically lower, so it's important to factor that into your planning.
Dividends are taxed as a distribution of income first for a MEC policy unless they are retained by the insurer as premiums or other considerations for the policy. Dividends held to accumulate at interest, or retained to repay loan principal or interest, are considered MEC distributions. MECs must still meet the definition of life insurance so cash value accumulations on a MEC are generally not subject to current tax if not withdrawn. However, if a MEC is pledged as collateral for a loan or a policy loan is taken, then any gains up to the amount of loan or pledge will be recognised.
Distributions from a MEC are taxed as earnings first, followed by a return of the policy's cost basis. Therefore, distributions are taxable to the extent of gain. For this purpose, loans, pledges, and collateral assignments of a MEC are treated as distributions. Policy loans that are eliminated during a 1035 exchange are taxable to the extent of any gain in the policy at the time of the exchange.
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Death benefits
If you sell your policy for more than what you’ve paid in premiums, the gain on that amount could be taxed. The new owner of the policy may face taxes on any death benefit they receive that exceeds what they paid for the policy, plus any premiums they’ve continued to pay.
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Estate taxes
If you sell your life insurance policy for more than you’ve paid in premiums, the gain on that amount could be taxed. This is because any amount above the cash value is subject to capital tax gains.
If you own a term life insurance policy when you pass away, the death benefit becomes part of your taxable estate. This could push your estate’s total value above the federal estate tax exemption ($13.99 million in 2025), triggering estate taxes. While this generally impacts only high-net-worth individuals, some states have a state estate tax as well and are typically lower thresholds, so it’s important to factor that into your planning.
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MEC policies
Life insurance is generally not taxable. However, if you sell your policy for more than you've paid in premiums, the gain on that amount could be taxed. Additionally, the new owner of the policy may face taxes on any death benefit they receive that exceeds what they paid for the policy, plus any premiums they've continued to pay. If you own a term life insurance policy when you pass away, the death benefit becomes part of your taxable estate.
Unlike traditional life insurance policies, MEC policies are subject to taxation on distributions. This means that any gains made on the policy, such as dividends or interest earned, are generally taxable as income. Dividends, in particular, are taxed as a distribution of income first for a MEC policy unless they are retained by the insurer as premiums or other considerations for the policy. Loans, pledges, and collateral assignments of a MEC are also treated as distributions and are taxable to the extent of any gain.
However, it's important to note that cash value accumulations on a MEC are generally not subject to current tax if they are not withdrawn. This means that as long as the cash value remains in the policy, it is not taxed. Only when distributions are made, such as withdrawals or surrenders, do they become taxable. Additionally, if a MEC is pledged as collateral for a loan or a policy loan is taken, then any gains up to the amount of the loan or pledge will be recognized and taxed accordingly.
It's worth mentioning that policy loans on MEC policies are treated differently from traditional life insurance policies. In the case of a MEC, policy loans are not considered distributions unless the policy lapses while the loan is outstanding. This means that taking out a loan against the value of your MEC policy will not trigger immediate taxation. However, if the policy is surrendered or cancelled with an outstanding loan, the loan amount will be treated as a distribution and taxed accordingly.
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Frequently asked questions
A taxable gain on life insurance is when you sell your life insurance policy for more than what you’ve paid in premiums.
If you sell your life insurance policy for more than you paid in premiums, the gain on that amount could be taxed.
If you own a term life insurance policy when you pass away, the death benefit becomes part of your taxable estate.
A MEC is a type of life insurance policy where distributions are taxed as earnings first, followed by a return of the policy’s cost basis.
If you take out a loan against your MEC, any gains up to the amount of the loan will be recognised and taxed.
