Paul Sanchez
Life insurance premiums are generally considered a personal expense and are not tax-deductible. However, there are certain situations where payouts will be taxed. For example, if your employer provides life insurance as part of your compensation package, the IRS considers it income, and you are taxed on any amount over $50,000. If you are the beneficiary of a term life insurance policy and receive a payout in installments, you will be taxed on any interest accrued. If the policy is a Modified Endowment Contract, policy loans are taxable if the policyholder is under 59 and a half years old.
When is personal term life insurance taxable?
| Characteristics | Values |
|---|---|
| If the policy is a Modified Endowment Contract | Policy loans and/or distributions are taxable to the extent of gain and are subject to a 10% tax penalty if the policyowner is under 59½ |
| If the beneficiary isn't named in the policy | Life insurance benefits will go into a taxable estate. As of 2025, the first $13.9 million is not taxed at a federal level, but anything above this amount is subject to taxation. |
| If the death benefit is paid out in installments rather than a lump sum | The death benefit itself is typically not taxed, but any interest that accumulates on those installment payments will be taxed as regular income |
| If the policy is a split-dollar arrangement | The employee is taxed on the term insurance value of the life insurance policy's death benefit in excess of the employer's share of the policy death benefit, usually equal to the policy's cash value |
| If the policy is a split-dollar loan | The employee must pay or be taxed annually on a market rate of interest on the outstanding split dollar loan amount |
| If the policy is transferred to the owner | Any gain in the policy is taxable to the owner at the time of the transfer |
| If the employer pays for life insurance | The premium paid on policy amounts above $50,000 is considered part of the taxable income |
| If the policy is carried directly or indirectly by the employer | 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 |
| If the policy is not considered carried directly or indirectly by the employer | There are no tax consequences for the employee |
| If the policy is a de minimis fringe benefit | The cost of employer-provided group-term life insurance on the life of an employee's spouse or dependent, paid by the employer, is not taxable to the employee if the face amount of the coverage does not exceed $2,000 |
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What You'll Learn
Life insurance premiums are not tax-deductible
Life insurance premiums are generally not tax-deductible. The IRS considers them a personal expense, similar to buying a car or paying for a cell phone service. However, there are certain exceptions and specific situations where life insurance premiums can be tax-deductible.
If you are self-employed or a business owner, you may be able to deduct premiums for health, dental, and long-term care insurance. Additionally, if you are a participant in a qualified plan, such as a 401(k), and the plan includes limited life insurance coverage that meets IRS requirements, the premiums can be tax-deductible. In this case, the amount used to purchase life insurance cannot exceed 50% of the employer's contribution to the plan.
Businesses can also receive tax benefits for group term life insurance premiums they pay. If the business is not a direct or indirect beneficiary of the policy, they may be able to deduct premiums on group term life coverage up to $50,000 per employee. In this case, the employee typically owns the policy. Additionally, if the business provides life insurance coverage for the spouse or dependent of an employee, with a face amount not exceeding $2,000, it is considered a de minimis fringe benefit and is not taxable to the employee.
In the case of divorce or separation, if the agreement was finalized before 2019 and requires one spouse to pay life insurance premiums for the benefit of the other spouse, it may be deductible as alimony. Furthermore, life insurance premiums paid for shareholders who own 2% or more of an S corporation may be deductible as compensation.
While life insurance premiums are generally not tax-deductible, it is important to note that the death benefits from life insurance policies are typically not subject to federal income tax. Your beneficiaries will usually receive the full amount, and the money paid out is generally tax-free.
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Interest on life insurance is taxable
In the United States, the Internal Revenue Service (IRS) considers life insurance to be a personal expense. As such, life insurance premiums are not tax-deductible. However, interest on life insurance is taxable.
Interest on Whole Life Insurance Policies
Whole life insurance policies accumulate cash value as policyholders pay premiums. Interest generated from whole life insurance policies is not taxed until the policy is cashed out. When the policy is cashed out, the interest is considered interest income by the IRS and is subject to taxation.
Interest on Life Insurance Loans
Life insurance policy loans are generally not treated as distributions from the policy unless the policy lapses while the loan is outstanding. Interest is charged on an outstanding loan. If a policy loan is eliminated during a 1035 exchange, it is taxable to the extent of any gain in the policy at the time of the exchange.
Group-Term Life Insurance
If an employer provides group-term life insurance as part of an employee's compensation package, the IRS considers it income, and the employee is subject to taxes. However, this only applies when the employer pays for more than $50,000 in life insurance coverage. The premium cost for the first $50,000 in coverage is exempt from taxation. If the employer pays for a $100,000 life insurance policy, the employee must pay taxes on the portion above $50,000. The taxable amount is based on IRS tables, specifically the IRS Premium Table, and is subject to Social Security and Medicare taxes.
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$1.99
Employer-provided life insurance is taxable above $50,000
In the United States, the Internal Revenue Service (IRS) considers employer-provided life insurance as taxable income if it exceeds $50,000 in coverage. This is outlined in IRC section 79, which states that the first $50,000 of group-term life insurance coverage provided by an employer is excluded from taxation. However, if the coverage exceeds this threshold, the additional amount becomes taxable income for the employee. This is often referred to as "phantom income" because it increases the taxable wages reported on an employee's Form W-2, even though the employee does not directly receive this amount.
The taxable amount is determined using the IRS Premium Table, which outlines the cost per thousand coverage based on age groups. For example, a 70-year-old with $50,000 in insurance coverage above the $50,000 threshold would be considered to have an additional taxable income of $103 per month or $1,236 per year. The Premium Table is used regardless of the actual premium paid, and it may result in older employees with higher compensation being subject to higher taxes.
It is important to note that the employer's role in subsidizing or redistributing premium costs also affects the tax consequences. Even if employees are paying the full cost of the insurance, the benefit they receive due to the employer's role is considered taxable income. This is applicable when the employer pays any portion of the cost or arranges for premium payments where one employee's payments subsidize those of another (the "straddle" rule).
In the case of life insurance coverage for an employee's spouse or dependent, the cost is not taxable to the employee if the coverage amount does not exceed $2,000. This is considered a de minimis fringe benefit. However, if the coverage amount exceeds this threshold, it may be subject to taxation, and the same Premium Table rates apply as for the employee's coverage.
To summarize, employer-provided life insurance becomes taxable above $50,000 in coverage, and the additional amount is included in the employee's taxable income. The IRS Premium Table is used to determine the taxable amount, and the employer's role in affecting premium costs also has tax implications for the employees.
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Naming an estate as a beneficiary may trigger taxes
Naming an estate as a beneficiary is a common mistake that can trigger taxes and create several other problems. Firstly, it forces assets to go through probate, the legal process of proving a will and distributing possessions, which is public, time-consuming, and expensive. Secondly, it can cause non-probate assets to become subject to probate, and for IRAs and qualified retirement plans, there may be unfavourable income-tax consequences.
The required minimum distribution (RMD) rules generally allow an individual beneficiary to "stretch" distributions over their life expectancy. However, an estate has no life expectancy, so taxable distributions must typically be made over a shorter time frame than if an individual or qualifying "look-through" trust had been named as a beneficiary. This can result in delayed distributions and additional administrative costs.
To avoid these issues, it is recommended to name a revocable living trust, which allows control over how assets are managed and distributed while avoiding probate altogether. Alternatively, specific individuals, such as family members, friends, or charities, can be named as beneficiaries to receive funds directly. It is also important to review and align beneficiary designations with current realities and wishes, especially after major life events such as marriage, divorce, or the birth of children.
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Policy loans are taxable if the policy is a Modified Endowment Contract
A Modified Endowment Contract (MEC) is a life insurance policy that has lost its tax benefits because it contains too much cash. The MEC limits for a policy will depend on its terms and death benefit amount. The IRS no longer recognizes an MEC as a life insurance contract because the total collected premiums and cash value exceed federal tax-law limits.
In a traditional life insurance policy, you can borrow your cash value, including your earnings above premiums paid, without owing income tax. However, in an MEC, taking out your gains through a loan counts as a taxable withdrawal. The 10% premature penalty also applies before the age of 59 1/2. After you've taken out your gains, you could borrow the remaining cash value representing your premiums paid without owing taxes. While MECs are taxed differently than life insurance policies, it is important to note that death benefits remain tax-free.
MECs are typically purchased by individuals who are interested in tax-sheltered, investment-rich policies and who do not intend to make pre-death policy withdrawals. The tax-free death benefit makes MECs useful for estate planning purposes, provided the estate can meet qualifying criteria. To prevent a life insurance policy from becoming an MEC, avoid overfunding it within the first seven years.
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Frequently asked questions
Personal term life insurance premiums are considered a personal expense and are not tax-deductible. However, there are some exceptions. If you gift a life insurance policy to a charity and continue to pay the premiums, those payments are generally considered charitable donations and may be tax-deductible. Additionally, if you own a business and provide life insurance for your employees, the premiums you pay might be tax-deductible as a business expense.
If the policy is a Modified Endowment Contract, policy loans and/or distributions are taxable if the policyowner is under 59 and a half. If the death benefit from a term life insurance policy is paid out in installments rather than as a lump sum, any interest that accumulates on those payments will be taxed as regular income. If the payout is spread over time, your beneficiaries should be prepared to report the interest on their taxes.
Life insurance proceeds you receive as a beneficiary due to the death of the insured person are not usually includable in gross income and you do not have to report them. However, if you receive the proceeds and there is no named beneficiary on the policy, the money will usually go into a taxable estate. As of 2025, the first $13.9 million is not taxed at a federal level. Anything above this amount is subject to being taxed.
