How Payments Made Determine If Taxes On Life Insurance Are Due
It has often been noted that the only sure things in life is death and taxes and in many instances they tend to go together. In most cases, proceeds from a life insurance policy may be exempt from income taxes, but in many others, anything above the policy term amount can be taxed by the Internal Revenue Service. While the tax code spells out when taxes on life insurance become mandatory, there can be some confusion, especially for those without help with their taxes.
Essentially, the benefit payments made in a lump sum that do not exceed the face value of the policy do not require payment of taxes on life insurance. For example, if a person dies and leaves a survivor a policy $25,000 and the face value of the policy is $25,000 they will not be required to pay any taxes on life insurance as income.
However, if the face value of the policy is $25,000 and the benefits are earning interest due to the structure of the policy and the payout is $25,500, then the beneficiary will be responsible for taxes on life insurance of the amount over the face value, in this case $500 as interest income. The $500 is added to their gross income as interest earnings and the taxes are calculated with the rest of their income tax.
Annuities Have Different Calculator Being Used
In some instances, life insurance benefits are paid out over time, usually with a start and ending date, specifying an amount to be paid monthly or annually. With these type of policies taxes on life insurance benefits are calculated differently. They are calculated on the amount over the policy's value based on the annual payout for the life of the annuity payments.
For example, a policy has a value of $1 million payable over 20 years. During its lifetime the annual income may increase due to interest being earned by the annuity and the interest paid during the year will be considered taxes on life insurance. To calculate the allowable tax-free death benefit, divide the amount of the annual benefit and compare it to the total benefits divided by the life of the annuity. In this instance, the annual payout is calculated at $50,000 a year.
Any amount received by the beneficiary over $50,000 in that year will be considered as earned interest and will be subject to taxation. The $50,000 received will not be liable for taxes on life insurance, but as the annuity principal grows, the tax liability will also increase over the years.
