The common misconception is that life insurance is not subject to taxation, which is half-true and half-false. Life insurance is almost always not subject to income taxation; however, under current tax law (2003), it is still subject to estate taxation.
As a general rule, life insurance death proceeds are excusable from the beneficiary’s gross income (IRC Sec. 101(a)(1)).
Death proceeds from single-premium, term life insurance, periodic-premiums, or flexible premium life insurance policies are received income tax-free by the beneficiary regardless of whether the beneficiary is an individual, a corporation, a partnership, a trustee, or the insured’s estate (Treasury Regulation 1.101-1).
However, the death benefits may be subject to estate taxes, gift taxes, and any other inheritance tax.
This is a good reason to visit with an estate-planning professional – somebody who is appropriately licensed and qualified.
How to roughly calculate your potential estate tax:
1. Total you gross estate; including anything of value in which you have an ownership interest. For example, home and other real estate; retirement plan balances; stocks, mutual funds and other investments; and businesses and life insurance proceeds (not held outside your estate).
2. Subtract all allowable deductions, such as funeral and administrative expenses, mortgages, loans, credit card debt, charitable deductions, etc.
3. If you have a positive net estate, this is your net taxable estate.
4. Use the table below to calculate your tentative estate tax.
|Year||Exemption $||Maximum Tax Bracket||Unified Credit|
|2011||$1 million||45 percent||245,800|
|2013 & beyond||$5.25 million||40 percent||$1,772,800|
Your unified credit is subtracted from your tentative tax, if unused during your lifetime. The unified tax credit means that no federal estate tax is payable on a taxable estate equal to your exemption equivalent. Estate taxes are due when your tentative tax is greater than your unified credit.
Your estate may be valued at death or six months later, whichever is more beneficial. If you own a farm or closely held business, your method of paying taxes will be different.
Use this information to generate a rough idea of your potential estate tax. Be sure to check out the IRS website or consult with a properly certified estate-planning adviser.
Note: This information is based on certain life insurance policy, tax, and legal assumptions, but it not meant as legal or tax advice and is, also, subject to change. Only your attorney, accountant, or other tax professional can give you such advice. Please consult your tax adviser as rates and exemptions may be subject to change.
Steuer, author of Questions and Answers on Life Insurance: The Life Insurance Toolbook, has more than 25 years of experience and holds the Department of Insurance Analyst License (LA) as well as the Charted Life Underwriter (CLU) designation. Tony holds various leadership positions and has authored three books on the topic of life insurance.
Steuer’s work has been awarded the “Excellence in Financial Literacy (EIFLE) Award from the Institute of Financial Literacy for his The Questions and Answers on Disability Insurance Workbook and The Questions and Answers on Insurance Planner. Forbes named Questions and Answers on Life Insurance: The Life Insurance Toolbook as one of their top nine great investment books.
He’s also the founder of the Insurance Literacy Institute and creator of The Insurance Bill of Rights designed to empower consumers and to identify members of the Insurance Industry dedicated to strong professional standards.