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Is Life Insurance Taxable?

2021-11-17

You’ve taken care of your family financially by investing in life insurance in case something happens to you. But how much of that policy’s payout will they actually receive — and is your life insurance policy’s payout taxable?  

In this article, we’ll answer some common questions related to life insurance and taxes.

Are Life Insurance Payouts Taxable?

The short answer is usually not. For most situations, the money that your beneficiaries receive from your life insurance policy does not have to be claimed as gross income, so it does not have to be reported to the IRS. However, there are some exceptions:

  1. If you don’t name a beneficiary. In cases where no beneficiary is named, the insurance automatically goes to the estate, which may be taxable. The value of the estate must reach taxable thresholds to require tax payments. The federal threshold is $11.7 million, but state thresholds vary by location.

  2. If your state collects inheritance taxes. There are currently six states (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania) that tax inherited payout, property, or additional assets. The rate of the tax varies by state and can be as little as 1%, or as much as 20% of the payout. Each state that charges inheritance tax has its own set of rules and exemptions. For example, most states will exempt your spouse and sometimes your children if you were to die. Inheritance taxes are generally higher when your beneficiary is someone who is not a family member.

  3. If your beneficiary skips a generation. Generation-skipping taxes may apply if your beneficiary is either a relative that is more than one generation younger than you — such as a grandchild — or an unrelated person who is more than 37.5 years younger than you. However, generation-skipping taxes only apply if the amount reaches the same amounts as estate tax thresholds.

  4. If a third person is involved in the policy. If the policyholder, insured, and beneficiary are all different, the beneficiary may be taxed. As an example, if your parent (the policyholder) took a policy out on you (insured) when you were young, then later named your spouse as your beneficiary, your spouse might have to pay taxes on the payout.

Is Permanent Life Insurance Taxable?

Permanent life insurance, such as whole life and universal life, provides coverage that doesn’t run out, as well as a cash-building aspect that is tax-deferred. There are a few instances where you may have to pay taxes on your permanent policy:

  1. If you withdraw more money than you’ve paid in premiums. When you withdraw money from permanent life insurance, you are taking that money out with no plans to repay it. If you choose to withdraw, the amount will be deducted from your life insurance payout, and you may owe taxes if the amount you withdraw is larger than the amount you’ve paid in premiums.

  2. If you sell your life insurance policy. You can work with a broker to sell your permanent policy for cash. The broker usually takes a portion of the payout. If you still make a profit on the sale of the policy that is more than what you’ve paid into your policy, you may have to pay taxes.

  3. If you cancel your policy. If you decide to surrender your policy, not only will you lose the life insurance death benefit, you will often have to pay some extra fees. If the cash value you receive is higher than what you’ve paid in policy premiums, you will have to pay taxes on that interest.

Before you choose to take any of these steps, it’s best to talk with your insurance provider. There are generally many options available to help you get cash from your policy or reduce your premiums.

Is Term Life Insurance Taxable?

Insurance is paid with post-taxed dollars, therefore the death benefit is not taxable. However, if  premiums were paid with pre-taxed dollars, then the death benefit would be taxable.

Is Group Term Life Insurance Taxable?

If you have a group life insurance policy through the military or another job, the payout is generally not taxable, although the same exclusions discussed earlier may apply.

Contact AAFMAA to Learn More About Life Insurance

AAFMAA specializes in helping ensure the financial security and independence of servicemembers and their families. To learn more and to discuss your family’s specific life insurance needs, contact the Life Insurance team at 866-716-4579.

Common Questions

Yes, your AAFMAA policy will cover a death related to COVID-19 if you are an existing AAFMAA Member with a policy issued more than two years ago or prior to a COVID-19 diagnosis, even within the first two years the policy is owned. The only exclusion on AAFMAA policies is death by suicide within the first two years.

However it is important to note that death claims made against an underwritten policy issued within the last two years are contestable, regardless of the cause of death. Contestable death claims are reviewed and subject to denial if we find undisclosed material information that would have changed the outcome of the policy issuance decision.

Yes, if you are applying for a policy that requires medical underwriting, you must disclose a positive COVID-19 diagnosis. Not doing so would be considered material misrepresentation and could result in your policy being voided.

As mentioned above, death claims made against an underwritten policy issued within the last two years are contestable, regardless of the cause of death. Additionally, you don’t have to die for a material misrepresentation to void your contract. The policy can be voided at any point within the first two years if AAFMAA finds that you provided incorrect information about your health history and that the correct information would have prevented us from issuing the policy.

If you were diagnosed with having contracted COVID-19 prior to applying for life insurance and you failed to disclose that diagnosis on your application, your death claim could be denied. This is because, if you had disclosed your COVID-19 diagnosis, we would have followed current industry guidelines and possibly postponed acceptance of your application. In this case, your policy would be voided and your survivors would only receive a refund of the premiums you had paid.

No, the COVID-19 vaccine is classified as a typical wellness check, for which we do not require disclosures and do not deny death claims. We strongly suggest that our Members follow CDC recommendations and receive the COVID-19 vaccination as soon as they are eligible.

Industry guidelines indicate that a COVID-19 diagnosis may postpone acceptance of your application for a period of three weeks to 1 year following recovery, depending on the severity of symptoms and treatment. This timeline is subject to change as new information becomes available and industry guidelines are adjusted accordingly. Those who experience a full recovery may be considered for issue before 12 months, while serious cases (such as those which required a ventilator) may be postponed for longer.

No. Receiving a COVID-19 vaccination will not affect the acceptance of your application.

No, AAFMAA cannot change your premiums or your health classification on a policy you currently hold. Your premiums and health classification will remain the same, even if you have been diagnosed with COVID-19 or you are at a higher risk of exposure due to your job, living situation, or recent travel, or if you get one of the COVID-19 vaccinations approved for emergency use by the USFDA.