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Is Life Insurance Taxable?


Each year, when tax time comes back around, we all start to think about how much we may have coming to us, or how much we may owe. One thing you may not stop to think about is if your life insurance policies are taxed.

Whether or not your life insurance benefits are taxable depends on a variety of factors. Military life insurance requires careful financial planning to fully understand your many tax benefits and liabilities. We’ll delve into tailored strategies and insights that can help you optimize your financial outcomes with insights specifically for military personnel so that you can better understand life insurance tax strategies for tax-deferred growth and tax-free death benefits.

The Taxability of Life Insurance

Anyone planning their financial future must understand the implications of taxes on life insurance. This is especially true for servicemembers and their families.

Life insurance can be a valuable financial tool, offering protection and peace of mind, but navigating the tax landscape is essential for maximizing its benefits. If you’re wondering whether life insurance proceeds are taxable and under what circumstances, look below for a breakdown of the taxability of life insurance.

General Tax Treatment of Life Insurance Policies

In most cases, life insurance policies have favorable tax treatment. While the premiums paid are generally not tax-deductible, beneficiaries receive a tax-free death benefit. Moreover, permanent life insurance policies, such as whole or universal life, provide tax-deferred cash value accumulation. The policyholders can also borrow against the cash value in some cases without triggering immediate taxes. However, surrendering the policy may result in taxes on any gains beyond the total premiums paid.

Are Life Insurance Death Benefit Payouts Taxable?

In general, life insurance payouts are not subject to taxes for the beneficiaries, which means they receive the full amount of the death benefit without a taxable liability. However, if the insured person fails to designate a beneficiary, the payout may be subject to estate taxes.

Moreover, six states impose an inheritance tax on the beneficiary, and generation-skipping taxes may apply in some family structures. Finally, if a third party owns the policy arrangement, this might trigger taxes for the beneficiary, as the benefits are now seen as a gift.

Tax Considerations for Military Life Insurance

For military personnel, the tax implications of life insurance are especially important. Life insurance benefits provide financial security, but navigating its tax landscape can take time and effort. We’ll delve into specific considerations and concerns relevant to servicemembers and their beneficiaries.

Taxation of Servicemembers’ Group Life Insurance (SGLI)

Like other forms of life insurance, SGLI death benefits are tax-free. This means that any payouts received from SGLI are exempt from taxation, providing greater financial security to servicemembers and their beneficiaries. This exemption is consistent across all branches of the military.

When a beneficiary receives the death benefit, they’ll receive their portion of the death benefit amount without any tax liability. For servicemembers, these benefits can offer peace of mind, knowing that your loved ones will receive a tax-free source of financial support in their time of need.

Death Gratuity is a lump-sum, tax-exempt $100,000 payment provided by the Department of Defense to immediately assist the survivor(s) of a deceased member of the Armed Forces. It is designed to meet the financial needs of the survivor of a servicemember who dies during Active Duty.

Tax Treatment of Veterans’ Group Life Insurance (VGLI)

VGLI is designed to provide equivalent coverage when a servicemember has elected this coverage when they transition from Active Duty to Veteran status. Like SGLI, VGLI is also exempt from taxes.

Tax Planning Strategies for Military Personnel

To maximize the tax benefits mentioned earlier and minimize liabilities, servicemembers and their beneficiaries should consider the following strategies.

Utilize Military-Focused Resources

Military personnel can benefit from specialized tax resources that offer valuable insights and guidance on tax deductions, credits, and exclusions tailored to their unique circumstances. These resources ensure that servicemembers receive the maximum tax benefits they are entitled to.

Explore Life Insurance Tax Strategies

When it comes to financial planning, life insurance can be a valuable tool that offers several tax strategies. One is tax-deferred growth, which means if you have a policy such as AAFMAA’s Value Added Whole Life policy, the growth of your life insurance policy's cash value is only taxed once you withdraw it. This can help you save more money in the long run, as you're able to compound your investment earnings without being subject to annual taxes.

Another tax strategy is tax-free death benefits. This means that the money your beneficiaries receive after your passing is not subject to income taxes, estate taxes, or inheritance taxes. This can be particularly beneficial for those with large estates or high net worth because it helps ensure that your heirs receive as much of your wealth as possible.

Incorporate Life Insurance into Estate Planning

Integrating life insurance into your estate planning can bypass probate and reduce estate taxes. Trusts can safeguard the death benefit and ensure it reaches your beneficiaries as intended.

Learn More About Life Insurance with AAFMAA

At AAFMAA, we understand the unique needs of servicemembers, military families, and Veterans. We’re ready to help you plan for financial security and independence through all stages of life and service. Contact us today to learn more and to discuss your family’s specific life insurance needs.

This article was originally published November 17, 2021.