Life Insurance Income Tax, Estate Tax & Benefit Tax
Purchasing life insurance is one of the most important decisions you can make in your lifetime, and it’s also one of the scariest. Most people do not want to even consider the fact that they will die, let alone put a price on that death. However, naming a beneficiary to receive the death benefits is just as important as purchasing the policy.
Naming the Beneficiaries
Married people usually name their spouse as their beneficiary. Make sure you specifically name your spouse – Mary Smith, for example – instead of generically writing “spouse.” And if you get divorced, contact your insurance agent so you can update your beneficiary designation, quickly.
Some people will also name their children, but you must be careful when naming minor children as beneficiaries. If you pass away while they are still minors, they will not immediately receive the death benefits the way you originally intended for them to. Instead, you should name a guardian you trust who would be responsible for the proceeds until they are adults.
Another situation occurs when you name your “children” or “grandchildren” as the beneficiaries. Were you expecting to include your step-children or step-grandchildren or exclude your adopted children? Sometimes when you specifically name your children, if you don’t update the beneficiaries regularly, you may unintentionally exclude your 3 youngest children born after you purchased the policy, for example.
Since there can be unintended exclusions and inclusions when improperly naming beneficiaries, you should follow the advice of your insurance agent or financial advisor when choosing and naming life insurance beneficiaries. Plus, the last thing your family needs to discover after your death is to find out that there were mistakes made which cannot be unmade, or that you really did intent to change your beneficiary from your children and grandchildren to your 25-year-old bride of 3 weeks.
Is Life Insurance Taxed?
Once the insured has passed away, one of the major financial concerns for the beneficiary is taxes, and rightfully so. The good news is that life insurance benefits are generally not taxable. But if you choose to have the insurance company hold on to your money to be distributed in multiple payments or at a later date, the interest earned on the principal balance is subject to taxes, although the principal is not. Also, if there is not a specifically named beneficiary, the life insurance proceeds may be subject to taxes.
Other situations can subject the life insurance death benefits to taxes, like selling your insurance policy, but those situations are not really common. If you plan on selling your insurance policy in order to generate cash before your death, please consider all of the pros and cons before doing so. This type of transaction is more complicated than you would think.
Review Your Beneficiary Designations Annually
As a final reminder, you should review your life insurance beneficiaries at the same time you hold your annual insurance review with your agent, or sooner if your family grows or one of your beneficiaries passes away before you do. You want to ensure that your beneficiary designations are current to avoid problems with the proceeds after you have passed away.