05 Mar Is a term life insurance payout tax-free to beneficiaries?

Q. Does a term life insurance policy pass through to the non-spousal beneficiaries such as adult children on a tax-free basis in the same way a whole or universal life policy does?
— Insured

A. Life insurance is often used so provide beneficiaries with a windfall after the insured dies.

According to IRC 72, the Internal Revenue Code that outlines all the rules, life insurance proceeds are generally income tax-free, said Ed Gaelick, a Chartered Life Underwriter and Chartered Financial Consultant with PSI Consultants in Glen Rock.

That would be regardless of the type of insurance such as term, universal, variable or whole life, he said.

But there’s an important distinction to make.

While most life insurances would be income tax free, they’re not necessarily free of the estate tax, he said.

There is no longer an estate tax in New Jersey but federally, you could be subject to the tax if an estate exceeds $11.4 million in 2019 or $11.58 million in 2020. And the rate could be as high as 40%.

Gaelick said certain transactions can negate the income tax free advantage of life insurance.

One example is a “transfer for value.”

“So if a parent had transferred ownership of their policy to a third party, who then named themselves as beneficiary, upon their death, benefits would be income taxable,” Gaelick said. “However there are several exceptions that still allow the tax free status.”

There are some other exceptions, so you should run your specific situation by your tax advisor.

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This story was originally published on March 5, 2020.

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