Q

Is life insurance tax-deductible?

A

Life insurance premiums usually aren’t tax-deductible, with the exception of some business owners

Zack Sigel

Zack Sigel

Published October 4, 2019

When you have a life insurance policy, the life insurance company will pay out a death benefit when you die. You decide ahead of time who receives the benefit, and then all you have to do is to keep your policy active by making regular payments.

The monthly (or annual) payments you make to keep a policy active are your premiums. Premium payments are typically affordable — especially with term life insurance — but your payments can add up over time.

Unfortunately, your life insurance premiums are not tax-deductible, with rare exceptions. Basically, you can never deduct life insurance premiums from your taxes if you bought a policy for yourself (meaning it pays out upon your death). The only exceptions are when you pay premiums for someone else’s policy.

Self-employed individuals also cannot deduct their premiums, even though they can deduct other expenses, like health insurance premiums.

On the flip side, the person receiving a death benefit (your beneficiary) doesn’t have to pay taxes on the money they receive. If you receive a $1 million death benefit, you don’t have to pay taxes on that $1 million.

In this article:

Quick review: what is a tax deduction?

An income tax deduction reduces how much of your income you actually have to pay taxes on. You generally qualify for tax deductions when you spend money on certain things throughout the year, (like mortgage interest. Then you can account for that spending on your tax return by excluding it from your taxable income.

If you had $50,000 in taxable income but you qualify for $5,000 in tax deductions, you only have to pay taxes on $45,000 of your income. Your income minus deductions give you your adjusted gross income (AGI) and then you apply the income tax brackets to determine how much you actually have to pay in taxes.

Why life insurance isn’t tax-deductible

Life insurance usually isn’t tax-deductible because it’s considered a personal expense, just like purchasing clothes or any other product. Neither the federal government nor any state requires you to buy life insurance.

(This is why premiums for disability insurance aren’t tax-deductible, either.)

The upside is that when you die and your beneficiaries receive the death benefit, the payout is tax-free as long as you paid the premiums yourself. A benefit payment is not considered income on your income tax return.

When life insurance premiums are tax-deductible

There are a couple of cases where you can deduct your life insurance premiums on your tax return. They apply when you are paying premiums for someone else’s life insurance policy, and they have their own exceptions to consider.

You run a business

Certain types of business owners can deduct premium payments they make for their employees. This can apply to LLCs, S corporations, and sole proprietorships.

To qualify, you must provide life insurance as an employee benefit and neither the business owner nor the company can stand to benefit from the policy. That means employers cannot deduct premium payments if the employer or the company is the beneficiary for an employee’s policy.

You also may not qualify if you and your spouse are in business together. Let’s say you’re a business owner, your spouse is an employee, the company pays your spouse’s life insurance premiums, and you are the beneficiary. You (the business owner) would benefit from an employee’s policy, so the premiums aren’t tax-deductible even though the employee is your spouse.

There’s one other exception to know. You can only deduct premiums for the first $50,000 of insurance coverage for each employee. Any amount of coverage you pay for beyond that is considered wages for the employee. You will need to report it on their W-2 form and the employee will pay taxes as with other income. This greatly limits the usefulness of the deduction since most people need a life insurance policy that’s 10 to 12 times their income.

Alimony agreements before 2019

If you have an alimony agreement or divorce decree that went into effect before 2019, and it requires you to purchase a life insurance policy on behalf of your ex-spouse, it’s possible to deduct your premium payments. If you already have a life policy and your alimony agreement says you have to name your ex-spouse as the beneficiary, those premiums are not deductible.

Any alimony agreements that took effect in 2019 or later are not eligible for this deduction because of recent tax code changes. For more on what you can deduct this year, see our guide to filing this year’s taxes.

If you need more help understanding whether your premium payments are taxable, it’s best to talk with a tax professional.

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Do you ever pay taxes on life insurance?

Under normal circumstances, beneficiaries don’t have to pay taxes on life insurance benefits and you don’t need to pay any taxes on your policy during your lifetime. There are a few instances when you have to pay taxes on your life insurance, though. This generally applies to insurance policies that have a cash or investment component (like permanent life insurance policies).

We’ll highlight a few instances below but you can learn more in our guide to when life insurance is taxable.

Your life insurance policy gained interest

Term life is enough for most people’s needs. You get life insurance coverage for a certain number of years (the term) and then you stop making payments when the term ends. Some people prefer a whole life insurance policy, which covers you for the rest of your life. Whole life policies have a cash-value component that works like a savings account and can gain you interest. Interest you earn is probably taxable.

The cash-value aspect of whole life is unique, so here’s an article on how whole life insurance works to help you understand it.

You bought somebody else’s life insurance policy

It’s possible to sell your life insurance policy for cash. Whoever you sell it to will continue to make the premiums on the policy and will also get the death benefit when you die. In return, you get a lump-sum cash payment when you sell.

If you buy someone’s life insurance policy, you may have to pay taxes on part of the death benefit.

Selling a life policy, called a life settlement, usually isn’t the best option. For example, you can decrease the size of the benefit if you want lower insurance premiums. But here’s when you should consider selling your life insurance policy.

You surrendered your life insurance policy for cash

As mentioned earlier, whole life insurance policies have a cash-value component. This is like a savings account you can withdraw from, but the size of your benefit goes down when you withdraw money. This is called a cash surrender and it’s useful if you need money in a pinch, but you will pay taxes on any cash-surrender value that exceeds the value of the total premiums you’ve paid.

Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.