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When it comes time to filing taxes on your yearly income, you may not always remember which type of income is taxable and which isn’t. Since life insurance benefits are a type of income, you may wonder if life insurance benefits are taxed.
In a life insurance policy, a person pays into an agreement with an insurance company. In turn, the selected insurance company will provide a payment to the beneficiaries of the insured person at the time of their death. This payment may also be made after a period of time, according to the agreement. The person who owns the life insurance policy chooses it based on their needs and their goals.
Life insurance is generally not included as gross income. So, people receiving life insurance benefits do not have to report those benefits as an income. However, if interest is paid out on the life insurance benefits, then that interest is taxable and must be reported as such.
Interest is generated when the policyholder decides to hold the payout of the benefits for a period of time instead disbursing a lump sum upon their death. Also, if the beneficiary receives incremental payouts over time, the payout will also accrue interest during the years it is being paid and will be taxable as well.
Cash value life insurance provides death benefit coverage for a lifetime in addition to an investment account. The policyholder pays part of the premiums into the investment account and that money grows with interest over time. With this type of insurance, you can withdraw from the account as well. And, as long as you do not withdraw more money than you have paid in, it will not be taxed as income.
When it comes to any life insurance policy, be sure to do your research on what to expect. Also, go through the specific life insurance policy ahead of time to learn how the policy is set up. Alternatively, if you are the policyholder, sit down with your beneficiaries and show them how it has been set up and what steps to take when it is time for them to receive the benefits. This will prevent any confusion in the future.