What is Inheritance Tax on Life Insurance? When most people think of inheritances, property, heirlooms, and other assets come to mind, but you could pay tax on life insurance proceeds as well. In general, inheritance tax is simply a percentage taken by tax authorities from anything that constitutes unearned income from someone who has passed away. Sometimes, you might hear people and resources refer to this as an estate tax because it more clearly includes every element of the deceased persons wealth and property left to the surviving. But, the IRS and states define inheritances and estates differently, meaning multiple tax categories could apply. When a life insurance policy specifies that its payouts should be placed in the policyholders estate, there is the possibility that death benefits will be taxed, but only in certain circumstances. In the majority of situations, designating an individual to be the beneficiary of the policy will make the death benefit completely tax free. Several factors go into whether an estate and its life insurance benefits are considered taxable. These often include:
Estate Property Value
State-based Regulations
Beneficiary Relationship
Secondary Beneficiaries
Type of Insurance Benefit To see if these apply to you, here is a brief overview of the kinds of features that will make your life insurance taxable as a qualifying inheritance. As you consider them, note the ways that making an estate a beneficiary rather than an individual could significantly reduce the effectiveness of your insurance policys financial protection. Then, you can decide how to retain as much value as possible.