Life Insurance and Taxes: What’s Taxable, What’s Not?

Are Life Insurance Premiums Tax-Deductible?

For most people, the premiums you pay for personal life insurance are not tax-deductible. The IRS treats them as a personal expense, much like groceries or your utility bill. The main exception is if your policy is considered a business expense—for example, if a company provides life insurance for employees. In that case, the business may be able to deduct the cost, but the employee could face tax implications depending on the coverage amount.

If you’re self-employed, premiums for personal life insurance still aren’t deductible unless they’re part of an employee benefits program.

Are Life Insurance Death Benefits Taxable?

In most cases, the death benefit from a life insurance policy is paid out tax-free to your beneficiaries. This is one of the main reasons life insurance is so valuable—it allows your loved ones to receive the full amount without having to give a chunk to the IRS.

However, there are a few situations where taxes can apply:

• Estate Taxes – If the payout causes your estate to exceed the federal estate tax threshold (or a state’s threshold), it may be taxed as part of the estate.

• Interest Earnings – If the insurance company holds the payout and pays interest over time, that interest is taxable as income.

• Transfer for Value Rule – If you sell your policy to another person, the payout they receive may be taxable.

How Cash Value Policies Are Taxed

Permanent life insurance policies, like whole life or universal life, have a cash value component that grows over time. The growth is generally tax-deferred, meaning you don’t pay taxes on it as it accumulates. But taxes can apply if you:

• Withdraw More Than You Paid In – If you take out more than your total premium payments, the excess is taxable as income.

• Surrender the Policy – Giving up your policy for its cash value can trigger taxes on the gain.

• Borrow Against the Cash Value and Let the Policy Lapse – The IRS may treat the unpaid loan as taxable income.

The good news is that loans against your cash value aren’t taxable as long as the policy stays active.

Group Life Insurance and Taxes

If your employer provides life insurance, coverage up to $50,000 is generally tax-free. But if the coverage amount is higher, the value of the extra coverage is considered taxable income and will show up on your W-2.

For example, if your employer provides $100,000 of coverage, the cost of $50,000 worth of coverage could be added to your taxable income based on IRS tables.

Taxation of Accelerated Death Benefits

Some policies allow you to receive part of your death benefit early if you’re diagnosed with a terminal illness. These “accelerated death benefits” are typically tax-free if you meet the IRS definition of terminally or chronically ill. But in rare cases—like receiving the benefit as part of a settlement—there could be taxes owed.

Strategies to Minimize Tax Impact

• Name the Right Beneficiary – This can help avoid estate taxes if the payout might push your estate over the limit.

• Consider an Irrevocable Life Insurance Trust (ILIT) – This can keep the payout out of your taxable estate.

• Avoid Unnecessary Withdrawals – Letting the cash value grow tax-deferred can be more beneficial in the long run.

• Coordinate With Other Assets – A financial advisor can help you plan your life insurance in line with retirement accounts, investments, and estate plans to minimize taxes overall.

The Bottom Line

For most people, life insurance benefits are tax-free, making them a powerful financial tool. But under certain circumstances—like large estates, employer-provided coverage over the limit, or cash value withdrawals—taxes can apply. Understanding these rules helps you make the most of your coverage and avoid surprises.