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How your insurance affects your taxes

Est. 7 min read

Insurance and taxes. They go together like…

Like…

Wait, what do insurance and taxes go together like? Do insurance and taxes even go together at all? What insurance benefits are taxable? What insurance payments can you deduct come April?

Insurance and taxes are two major financial obligations, so surely there must be some sort of relationship between the two, right? Let’s dig into four major insurance products – life insurance, health insurance, long-term disability insurance, and homeowners insurance – and find out what each of them means to your bottom line while they’re serving as your financial safety net.

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Life insurance and taxes

Life insurance is meant to serve as income replacement for your family if you’re not around to provide for them. It’ll pay for debt, mortgage, college, and more. You probably don’t want any of that much-needed money going to Uncle Sam, right?

For better or worse, term life insurance is mostly unaffected by taxes. Better, because that lump sum of money that your beneficiaries receive isn’t taxable. Worse, because your life insurance premiums aren’t deductible, which means no reducing your taxable income in April.

However, there are a few exceptions to the impact that taxes have on your life insurance.

First, if your beneficiaries elect to receive the death benefit as installments rather than a lump sum, some of that will be taxed. That’s because as the life insurance company holds onto that money, it’ll gain interest, and that interest is taxed.

Permanent life insurance policies have a cash value component that can grow over time. If you surrender permanent policies early, you may be taxed on the cash value component. Note that this doesn’t affect term life insurance policies – the type of policy we recommend for most customers – so if you have a term policy, you can ignore this. But now you know!

If the death benefit is included in your estate, it may be taxed. But considering that estate taxes only apply to estates valued at around five and a half million dollars, this probably won’t affect most people.

If you get group term life insurance coverage through your work and your employer is paying for any part of it, any coverage over $50,000 will be treated as income, and you’ll be taxed accordingly. If you need additional coverage but don’t want to be taxed, consider buying a private life insurance policy to supplement your group plan.

Finally, if you sell or transfer your life insurance policy for monetary value, that may have taxable implications for beneficiaries.

For freelancers out there who don’t have any sort of group coverage but need life insurance (which, really, is all freelancers), you unfortunately don’t get any special deduction powers. The same rules apply to you as to salaried workers, with the exception that you get to avoid any confusion from employer-sponsored coverage.

Health insurance and taxes

Are you ready for things to get complicated?

Introducing: Health insurance!

It’s not really that confusing, but when it comes to taxes, health insurance has a lot of caveats that actually affect many people (as opposed to legitimate-but-edge cases found in other insurance/tax relationships).

First, let’s talk about the individual mandate. You know how the Affordable Care Act made health insurance mandatory? Well it did that with the individual mandate, which is a tax penalty imposed if you don’t have health insurance. The individual mandate is $695 per adult in your household ($347.50 for minors) or 2.5% of your gross income, whichever is higher. This penalty is added to your taxes, so it’s not like you’re just cutting the government a check randomly.

Also keep in mind that the penalty assumes a full year without health insurance; if you had health insurance for six months out of the year, you wouldn’t need to pay the full penalty. The law also allows for “short gap” exemptions. For a full rundown of how these exemptions work, see our guide here.

But the tax law can also help you when it comes to health insurance! Since health insurance is mandatory, the Obama administration wanted to make it as affordable as possible, and that meant providing subsidies for people whose incomes fall between 100% and 400% of the poverty income level. One subsidy method is cost-sharing reductions intended to lower out-of-pocket costs, but the other is a premium tax credit.

If you qualify for the tax credit, you can receive it after filing your annual tax return with the rest of your refund, or you can elect to have the government advance a portion of it each month directly to your health insurance company, lowering the monthly costs of your health insurance plan.

Health savings accounts (HSAs) and flexible spending accounts (FSAs) aren’t directly connected to your health insurance, but they are related. FSAs are only available through your employer, and you’re only eligible for an HSA if you have a high-deductible plan. But both can have a big impact on your taxes: You can contribute money pre-tax to them, lowering your taxable income. That means deducting up to $1,300 for individuals and $2,600 for families from your taxable income with HSAs (numbers that are going up in 2017) or $2,550 with FSAs.

Freelancers can’t get health insurance through an employer and won’t have access to FSAs, but there are still some perks out there for you. First, the same mandate and subsidy rules apply, which means the same tax breaks (and penalties). Plus, you can still qualify for an HSA.

But here’s a key difference: Freelancers can deduct their premiums. The IRS notes that “you generally can deduct only the part of your medical and dental expenses that exceeds 10%” so it may not be all of your medical costs, but it can still reduce your tax bill by a lot.

Long-term disability insurance and taxes

As with life insurance, your long-term disability insurance premiums are not deductible, and the benefits you receive are not taxable … usually.

If you are enrolled in an employer-sponsored group disability plan, your benefits might be taxable depending on who is paying the premiums. If you’re paying them, your benefits (paid in the event of a disability) will be tax free. If your employer is covering the premiums, the benefits are taxable.

PolicyGenius long-term disability insurance

If the premium payments are split between you and your employer, the benefit is taxable based on the split – so if you’re splitting the cost equally, you’ll owe tax on 50% of the benefit that’s paid if you’re disabled.

Freelancers won’t need to worry about this since you don’t receive an employer-sponsored plan. So go ahead and buy your own long-term disability insurance policy and enjoy the tax-free, non-deductible peace of mind it provides.

Homeowners insurance and taxes

Finally, there’s homeowners insurance. Keep in mind that these scenarios usually apply to renters insurance as well.

First off, premiums for homeowners insurance aren’t deductible. That’s a bummer. However, portions of the deductible may be. That means that if you have insurance but have a $1,000 deductible before it kicks in, you may be able to write off $900 of that. You may also be able to write off the value of any possessions that aren’t covered by your insurance.

If you weren’t able to come up with a full down payment for a home and have private mortgage insurance (PMI), you can claim your PMI premium payments on your taxes.

Finally, you can write off homeowners insurance if you use your residence for business. For example, if you claim rental income from your home, you can claim the homeowners insurance on your taxes. You can do the same if you use your home as an office.

Keep in mind that in both cases you can only write off the portion of your insurance that’s equal to the portion of your home you’re using for business. So if your home office takes up 10% of your total home, you can write off 10% of your total homeowners insurance costs. Get even more tips and tricks on home office deductions here.

You shouldn’t choose your insurance products based solely on the tax breaks they’ll get you – you should get them based on how they fit into and protect your financial plan – but getting a few breaks along the way never hurts. If you want to know exactly how your insurance fits into your tax plan, be sure to consult a tax preparer or financial advisor before you file this year!

Published on January 13, 2017

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Colin Lalley writes for PolicyGenius, a digital insurance brokerage trying to make sense of insurance for consumers. He previously wrote for Lulu Press.
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