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Life Insurance

Does Life Insurance Get Taxed? Tax FAQs


Benjamin Franklin once wrote, “In this world, nothing can be said to be certain, except death and taxes.” Fortunately, life insurance can help you with both. It provides financial protection for your family when you die and it can help you with taxes while you are alive.

8 Life Insurance Tax FAQs

Although you should consult your tax advisor for specific advice in your particular situation, here are the most frequent questions AAFMAA Members ask us about the tax implications of their life insurance policies.

1. Do I pay taxes on the cash value growth in my whole life insurance policies?

No. On your annual statement detailing your Value-Added Whole Life and Wealth Builder Life Insurance policies, you earn interest based on AAFMAA’s crediting rate — beginning at 5.0%*. The cash value growing on your policies pays for policy expenses and is not taxable.

2. When I die, will my beneficiaries pay taxes on the death benefit?

No. The IRS generally does not tax death benefit proceeds.

3. If my beneficiaries leave the death benefit on account with AAFMAA, will the interest they earn be taxable?

Yes. Although payment of the death benefit is not taxable, the IRS considers interest paid on a death benefit as ordinary income and AAFMAA will report it on form 1099 if it is more than $600. If your beneficiaries choose a life annuity, they will receive a stream of payments for life — in part from the original non-taxable death benefit and also from the part that is taxable interest.

4. If I cash surrender my whole life policy, will I have to pay taxes?

Yes, probably. When you surrender your policy, AAFMAA will pay you the cash value of the current policy. The government will tax you the amount in that cash value that is greater than the premiums you paid. AAFMAA will report that amount, considered ordinary income, to both you and the IRS on Form 1099.

5. If I borrow through a policy loan, is that loan taxable?

No. For most “ordinary” whole life policies, the government does not tax the borrowed amount. For any policy that is a “Modified Endowment Contract” (MEC), including all Wealth Builder Life Insurance policies and other policies for which you paid a single premium, the government will tax proceeds from the loan that are greater than the premiums you initially paid for it as ordinary income — similar to surrendering the policy.

6. If I exchange one life insurance policy for another, do I have to pay tax on the gain?

No. In nearly all cases involving an exchange of one policy for another — known as a 1035 exchange — the government will not consider the gain as taxable income. The insurance company for the old policy will report the exchange to you on Form 1099-R, which you must record as part of your taxes, but the proceeds are not taxable if they are entirely used to purchase another life insurance policy.

7. If I receive my life insurance proceeds as a Long-Term Care Settlement, do I pay taxes on those payments?

No. Assuming the settlement payments amount to less than the IRS maximum ($330 per day) and you use them for qualified long-term care expenses, the government will not consider those proceeds as taxable income.

8. Is interest that I pay on my Career Assistance Program (CAP) Loan deductible?

No. The CAP Loan is a consumer loan and, as a result, the interest paid is not deductible.

When to Consult Your Tax Advisor about Life Insurance Taxes

If you have any specific questions, you should consult your tax advisor, or you can reach out to Military OneSource which provides tax assistance and financial counselors for active-duty servicemembers, spouses and dependent children of the eligible servicemembers. Members of the National Guard and Reserve — regardless of activation status. Retired and honorably discharged servicemembers, including Coast Guard Veterans, within 365 days of their discharge.

If you need more information about your policy, please contact Policy Services at [email protected].

*AAFMAA's crediting rate is currently 5.1% for Wealth Builder Life Insurance and 5% for Value-Added Whole Life for 2024. These rates are not guaranteed and are subject to change.

This article was originally published March, 16, 2016.