Under normal circumstances, the U.S. Internal Revenue Service (IRS) does not tax life insurance benefits. However, the beneficiary may have to pay taxes on the benefits they receive in some situations. As a life insurance policyholder, you should play your cards well to avoid leaving a tax burden on your beneficiaries. Here’s detailed information on this topic.
Situations in Which Life Insurance Benefits Are Taxable
The federal government does not consider life insurance benefits a taxable income. Even so, you can pay taxes on these benefits in the following situations.
When the Beneficiary Is an Estate
The beneficiary of a life insurance policy can either be a real person or an estate. The benefits will be taxable if you list your estate as the beneficiary on your life insurance policy. The taxes can be even higher if the estate is of high value. Even if there’s only one beneficiary named under the estate, the Internal Revenue Service will surely tax the benefits.
When the Benefits Accumulate Interest
Life insurance coverage matures upon the policyholder’s death. This means that the beneficiary can claim their benefits at such a point. While some beneficiaries claim benefits immediately following the policyholder’s demise, others take some time. Taking some time before claiming allows your life insurance benefits to earn interest. Although this is a good thing, you will have to pay taxes on the total interest earned during the delay period.
Tips to Avoid Paying Taxes on Life Insurance
To avoid paying taxes on your life insurance benefits entirely, use the following tips:
Transfer Policy Ownership
You should consider transferring ownership if you’ve named your estate as part of your life insurance policy. Estate funds are taxable by law, meaning the death benefits paid to the estate will also be taxable. The easiest way to avoid paying taxes is by transferring ownership of the policy to an individual rather than your whole estate.
Create a Life Insurance Trust
It is possible that your beneficiaries also have creditors watching them. Upon the policyholder’s death, creditors are likely to come looking, aiming to receive their payment from the life insurance benefits. You can create an irrevocable life insurance trust to protect life insurance benefits from creditors who may be out to seek the settlement of their debts. The same thing applies to taxation.
While the government may be out to tax your life insurance benefits, you can prevent this by creating an irrevocable life insurance trust. The insurance company will transfer the life insurance benefits to the trust upon your unexpected death. While you will lose some control over the funds, you will escape direct taxation. This is especially important if the beneficiaries are young or not in the right mental state to receive compensation. Trusts protect the benefits from creditors as well as taxation.
Get The Right Life Insurance Coverage You Need with CAV Insurance Agency!
Use the tips discussed above to avoid paying taxes on life insurance benefits. Importantly, contact our expert agents at CAV Insurance Agency today for more information on getting the right life insurance policy for you and your loved ones.