How to Avoid Taxes on Life Insurance Income

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of average funeral cost In 2021, wakes and burials were $7,848 and cremations were $6,971. The average cost to settle a property varies, but a complex property can easily drive up to $5,000. , and does not take into account the time spent on the sale.

The point is that death is as expensive as life. Life insurance is a popular way to pay for these costs, but many people forget one thing. If you are a life insurance beneficiary, there are some tax implications you need to be aware of.

Consider working with a local expert to help you with your wealth planning and life insurance choices. financial adviser.

How is life insurance taxed?

Life insurance is not taxed directly because it is not required to be declared as income to the IRS. That means you don’t have to pay income tax as a life insurance beneficiary. However, there are some “backdoors” that can introduce taxes and eat away at your earnings.

Let’s take a look at how governments are using alternatives to tax life insurance. This will give us a better understanding of how to avoid taxation everywhere.

gift tax

Gift tax is normally levied on the donor making the gift, but in the case of life insurance, gift tax can be enforced if there is a special tripartite relationship. She is usually the only person involved in a life insurance policy. One buys insurance to insure himself and he is the beneficiary who receives the insurance money. In this case, no gift tax is levied. However, if she has 3 people who play the 3 roles separately (listed below), it is applicable.

  • Policyholders: Purchasing an insurance policy

  • Insured: Is his life covered by insurance?

  • Beneficiary: Received when the insured person dies

gift tax avoidance

go around gift tax As a life insurance beneficiary, it’s usually not a problem for the average person. The gift tax applies only if the property value exceeds her $12.06 million after the insured passes.

If you fall into this category, you can expect to pay approximately 18% to 40% tax on your life insurance income. Otherwise, your sole responsibility is to report the gift. IRS Form 709 When you file your tax return for the year.

real estate absorption

Businessman's hand - contract - justice - hammer - on - table - SmartAsset

Businessman’s hand – contract – justice – hammer – on – table – SmartAsset

If you are the beneficiary of a life insurance policy from someone whose estate exceeds the estate tax exemption limit ($12.06 million), you may have to pay estate tax on that payment. If an insurance company owns property in excess of tax-exempt limits through life insurance earnings, those earnings are absorbed into the value of the property, and the excess value is taxed as inheritance tax owed to the heirs. real estate.

Avoiding property taxes

To avoid this loophole, property owners must prepare either a will or a trust, leaving you as the beneficiary. Other assets will then be liquidated to cover estate tax costs and you will receive the full life insurance proceeds tax-free.

otherwise you are looking at a lot of money federal estate tax Between 18% and 40%, depending on how large the income payment is and how much it exceeds the tax exemption limit on the property. Since this can be a difficult road to go down, hire a pro I strongly recommend it.

Installment payment of death benefit

Shot of a woman doing paperwork with her elderly mother at home - SmartAsset

Shot of a woman doing paperwork with her elderly mother at home – SmartAsset

Choosing a life insurance installment rather than a lump sum is popular, but can be costly. Lump sum payments for life insurance are tax-free, but installments are called annuities. This will create a lump sum interest bearing account. Interest accrued on that total is taxable.

Avoid interest tax on installments

The most obvious way to avoid this tax is simply to receive a lump sum. However, if you plan to invest in payouts, be aware that you are already one step ahead. With normal investments, the money invested is taxed when you earn it, and taxed again when you make a profit from the investment.

By investing in lump sums like life insurance payments, you are essentially skipping the first tax.


Most life insurance payments are tax-free. Responsibility for tax impacts usually rests solely with the insurer or policyholder. Additionally, most of these tax situations can be easily avoided if detected early.

real estate planning tips

  • consider talking to you financial adviser About how life insurance can help with estate planning and whether it makes sense for you. If you don’t have a financial advisor yet, finding one isn’t difficult. SmartAsset free tools will match you with up to three financial advisors who serve your area. You can interview Advisor Matching for free to determine which advisor is right for you. If you are ready to find an advisor who can help you reach your financial goals, get started now.

  • In addition to life insurance, there are other factors that can be included in a real estate plan.a last will and testament, for example, is a fundamental part of estate planning to ensure that assets are distributed as desired. A will can also be used to name guardians for minor children.

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