Introduction

This is a common question that comes up all the time: do you pay taxes on life insurance? The quick answer is no, you don’t pay taxes on the death benefit or cash value of your life insurance policy. However, it’s not quite as simple as that! There are some circumstances where you will have to report part of your benefits as income. We’ll explain how below and provide additional resources if needed.

There are two parts to this question.

The question is: “Do you pay taxes on life insurance?” There are two parts to this question, and the answer to each part is different.

Do you pay taxes on the death benefit?

There are two types of death benefits: the amount you receive from life insurance policies, and the amount you receive when your loved one dies. We’re going to focus on the first type of benefit in this section.

As you can see from our chart above, there are different tax scenarios based on whether or not you paid for your life insurance policy with money that was previously taxed (such as money from an IRA). If so, it will be considered income and taxed accordingly alongside other taxable income. However if you paid for your life insurance with pre-tax money (like from a 401(k) or 403(b) plan), the death benefit is not subject to taxes under current law (though some states do charge their own estate taxes). For example:

Do you pay taxes on the cash value?

The most important thing to remember about taxes on life insurance is that you have to pay taxes on the cash value of your policy.

Cash value is what’s left over after premiums have been paid out and claimed against. It also includes any additional money your insurer has put into the account, like dividends or interest earned on investments.

The main way you’ll pay taxes on this money is through interest income and dividends, which are both taxed as ordinary income at your marginal tax rate (i.e., if you’re in the 25% tax bracket, then 25% of any interest or dividend income will be due). You’ll only pay capital gains tax when there’s a capital gain—say, because you sold part of your investment portfolio or used some of your cash value to buy another asset—and even then it’s just 15%.

In addition to these forms of taxation, there are two other ways that people can end up paying taxes: withdrawals from their life insurance policy and beneficiary payments upon death.

Additional Resources

If you have any questions, consult a tax professional. If you still don’t know, it’s best to check with your life insurance company or read the fine print of your policy. The IRS also provides guidance on life insurance in Publication 560, but the information is broad and general in nature.

The quick answers are no and usually not.

The answers to whether you pay taxes on life insurance are no and usually not.

  • The death benefit is tax-free. You don’t pay taxes on the money that your beneficiaries receive when you die, so this will be free from federal income tax. (But if your state has an estate tax or other similar measure, it may apply.)
  • The cash value of your policy isn’t usually taxed each year. Because it’s considered equity in an investment product and not income from employment or investments, most people don’t have to pay taxes on any gains their policies make until they begin selling them off—and then only at their marginal rate (which could be as high as 39%).

Conclusion

There are two parts to this question. Do you pay taxes on the death benefit? The quick answer is no, although there are exceptions. Do you pay taxes on the cash value? The quick answer is usually not, but it depends on your policy and other factors such as where you live.

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