One common point of confusion for taxpayers is whether term life insurance premiums are deductible. The short answer is no—most life insurance premiums are not tax deductible.
In this post, we’ll present answers to common questions that you may have about life insurance premiums and IRS regulations this tax season.
Life Insurance Premiums Paid by Individuals Are Not Deductible
According to the IRS, life insurance premiums are personal expenses that are not eligible for deduction. There are a few exceptions to note:
Alimony Payments: If a spouse is ordered to pay alimony in a divorce case, a life insurance policy may be purchased to ensure that payments will continue if he or she dies. These life insurance premiums are tax deductible.
Charity-Owned Life Insurance: You can make cash gifts to equal the premium amount of a new life insurance policy insuring your life, owned by a charity. An income tax deduction is available for the amount of the cash given directly to the charity to cover the policy premium on your life. There must be a insurable loss to the charity when naming it as the owner and beneficiary of a policy.
Are you wondering what other types of insurance premiums can (and cannot) be deducted on your 2017 personal tax returns?
Review: IRS Publication 502 (2017), Medical and Dental Expenses. For life insurance premiums, review the section called Insurance Premiums You Can’t Include.
Business owners may wish to review IRS Publication 535 (2017) Business Expenses.
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Some Life Insurance Premiums Can Be Deductible as a Business-Related Expense
You may deduct life insurance premiums covering your officers and employees if you aren’t directly or indirectly named as a beneficiary under the contract.
For example, an employer providing group term life insurance coverage to employees may deduct the premium amount for the first $50,000 of coverage that the company purchases. Premiums that are paid by a company for coverage provided along with a non-qualified employee benefit plan, such as deferred compensation, may also be deducted.
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You can’t deduct premiums on some life insurance and annuities.
For policies issued before June 9, 1997, you can’t deduct the premiums on a life insurance policy covering you, an employee, or any person with a financial interest in your business if you are directly (or indirectly) named as a beneficiary of the policy.
You are included among potential beneficiaries if the policy owner is obligated to repay a loan from you using the proceeds of the policy.
A person has a financial interest in your business if the person is an owner or part owner of the business or has lent money to the business.
For policies issued after June 8, 1997, you can’t deduct the premiums on any life insurance policy, endowment contract, or annuity contract if you are directly (or indirectly) named as a beneficiary. This applies no matter who is covered by the policy.
You can’t deduct the life insurance premiums, if, as a partner in a business partnership, you take out an insurance policy on your own life and name your partners as beneficiaries.
If you take out a policy on your life (or on the life of another person with a financial interest in your business) to get or to protect a business loan, you can’t deduct the life insurance premiums as a business expense.
Nor can you deduct the premiums as interest on business loans or as an expense of financing loans. In the event of death, the proceeds of the policy are generally not taxed as income even if they are used to liquidate the debt.
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Certain Premiums Are Deductible for Employees
Employees participating in a qualified plan, such as a 401(k), may purchase a limited amount of term life or whole life coverage on a tax-deductible basis. These life insurance premiums will be tax deductible.
This coverage, however, must be considered incidental according to IRS guidelines. Provided that the policy is not an IRA or a Roth plan, the limit is 25% of the employer’s contribution amount, in addition to forfeitures. Death benefits paid are tax-free.
Now let’s take a look at some other important tax facts for insurance policy owners.
Fast Facts on Life Insurance as Reportable Income
There are a few situations to be aware of when your term life or whole life insurance policy may provide you with money that needs to be recorded as income. Here are two common scenarios:
Employer-Paid Life Insurance Taxation: If an employer offers life insurance to an employee as part of a compensation plan, the IRS considers this as income; the employee will have to pay tax on this amount. This is only applicable when the employer pays for more than $50,000 of coverage. Premium costs for the first $50,000 in coverage are exempt from taxes.
Prepaid Life Insurance Taxation: Certain plans allow the insured to pay a lump sum premium. This money is used to pay the life insurance premiums during the length of the plan. The amount of the payment increases in value because of accrued interest. The IRS considers this interest income subject to taxation when used to make premium payments—or if a policyholder withdraws some of the earned money.
Most life insurance premiums are not tax deductible, but there are a few exceptions for individuals and business owners.
Fast Facts on Death Benefits and Estate Taxes
Even though the beneficiaries of a life insurance policy may not have to pay taxes on a death benefit, they may pay taxes on the estate left to them.
Under the new tax law (valid from 2018 to 2025), an individual can leave up to $11.2 million to their family without having to pay a federal estate or gift tax; a married couple may leave $22.4 million (including an adjustment for inflation). This means that a gross estate value above these amounts will be taxed at the top rate (as of 2017) of 40%.
Here are some of the assets that may be calculated as a part of your estate:
- Retirement accounts (including 401(k) and IRA funds)
- Bank and investment accounts
- Real estate
- Personal property (cars, boats, jewelry, etc.)
- US savings bonds
And expenses that may be deducted from the gross estate:
- Funeral expenses
- Estate taxes paid to states
- Administrative and legal fees
Know that there is an unlimited deduction for transfers to a charity or a surviving spouse.
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Do You Have Enough Term Life Insurance to Cover Expenses and Estate Tax?
Is your current life insurance amount enough coverage for your future expenses?
For example, a husband and wife with four young children, a small business, and a home worth $600k, may take out a policies of $5 million each. They will want to factor in college expenses for all four children, loss of income if one of the parents passes away, debts, and contributions towards retirement for the surviving spouse.
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While $5 million per parent may seem like a huge amount, when factoring in personal and business debt, inflation, soaring tuition (estimated to be about $140k per year for a private university in 15 years), and uncertain retirement costs, this amount might not even be enough to provide for the basics that their loved ones will need.
Estate Tax Rates May Vary
As tax laws may change in 2025, the size of the estate exempt from tax may be very different than it is today, potentially dropping back down to 2017 levels ($5.9 million) or even less.
While it is impossible to determine what the estate tax will be when you (or a loved one) passes on, it is important to have a policy that offers sufficient protection for your family, if the appreciated value of your home, investments, and any business are subject to estate tax.
» Learn more: Estate Planning Is Not Just for the Wealthy
It’s critical to have the input of an insurance advisor to help you understand your insurance needs and how to prepare for economic uncertainty. Quotacy insurance advisors can help you find the right policy that will protect your loved ones at various stages during your life together.
Insurance Proceeds May Be Subject to Tax
- The policy is transferred for something of value (such as money or property).
- The rules of an Irrevocable Life Insurance Trust (ILIT) have been violated.
- You live in a state with inheritance tax.
- A beneficiary received the death benefit over a period of time and not in a lump sum (although the death benefit itself is not subject to tax, any accrued interest may be subject to tax).
- Your original policy did not have an insurable interest based according to the laws of your state.
There is an exception here.
If the insured owns the policy, then the proceeds will be included in the estate (and will be subject to tax). If, however, ownership of the policy is removed from the insured’s estate, the proceeds may be free of estate taxation. A common way to do this is through the use of an Irrevocable Life Insurance Trust (ILIT) that transfers policy ownership to a trustee who manages asset distribution after the insured’s passing.
While understanding tax law is a bit complicated, Quotacy’s insurance quoting tool makes it simple to find the right policy to help you meet your financial goals.
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