Is My Life Insurance Policy Going to be Taxed?

Life insurance can play a valuable role in estate planning, from providing cash to the trustee or executor to pay off debts and final expenses, to providing funds to pay off a mortgage or provide for college, or to replace an income for a surviving spouse and children. Sometimes it is even used to infuse cash into a business upon the untimely death of a partner, or in larger estates, to provide the liquidity needed settle up any estate tax liability without having to sell off any of estate’s assets.

However, when it comes to taxes, it is important to remember that with estate planning, we are often talking about two different kinds of taxes: income taxes and estate taxes. Life insurance is normally income-tax free to the beneficiary. (There are a few exceptions, particularly if the policy is used in business partnerships).

The key to remember is that while life insurance in most instances is income-tax free, it is still taxed under the federal estate tax rules, because the federal estate tax is a tax on the transfer of property. This transfer tax is assessed on the assets you leave to the next generation. Because of this, the proceeds of all the life insurance that you own or control is included in your taxable estate for purposes of calculating your estate taxes, even if the proceeds did not come into your estate.

There are, however, estate planning tools that can address the issue, such as an ILIT, an Irrevocable Life Insurance Trust, that may be used if an estate is facing a tax burden. Work with an estate planning attorney to determine the best tools to meet your specific needs, whether it is determining the role of life insurance in your estate, drafting a will or creating a trust.

Author Bio

Catherine Hammond is the CEO and founder of Hammond Law Group, a Colorado-based estate planning law firm she founded in 2005. With a strong focus on protecting families from the legal consequences of disability and death, she creates comprehensive estate plans that minimize taxes, costs, and government interference.

A native of Denver, Catherine completed her undergraduate studies at Coe College in Iowa, and her Juris Doctorate from the University of Denver College of Law in 1993, concentrating on estate planning, tax, and mediation. Catherine is a member of various professional organizations, including WealthCounsel, ElderCounsel, the National Academy of Elder Law Attorneys, the Colorado Springs Estate Planning Council, and the Purposeful Planning Institute. Beyond her legal expertise, Catherine provides transformational coaching to support clients and their families through life transitions.

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