Life insurance policies are a cornerstone of many estate plans. Unfortunately, not everyone who relies on life insurance to help support their loved ones is fully informed about the tax consequences of their coverage decisions.
The more complex insurance policies become, the more difficult it can be to determine whether the rules for “insurance” or “investments” should apply. To appreciate your options accurately, avoid making consequential decisions in a vacuum. Speak with an experienced estate-planning attorney first. That said, here’s a quick primer to help you avoid common mistakes:
- To count as “life insurance,” the contract must meet state and IRS requirements.
The Internal Revenue Service (IRS) and most states have specific definitions of a “life insurance policy.” A contract that doesn’t meet those standards won’t receive the same tax treatment as life insurance – meaning the tax costs may be far higher. Insurance companies that market a product as “life insurance” are expected to meet IRS standards.
- Don’t try to deduct your premiums on your federal income tax return.
The IRS treats life insurance premiums as a personal expense – a thing you buy for your own needs or enjoyment. As a result, the agency does not allow you to list your life insurance coverage premiums on your tax return.
- You may be taxed for life insurance even if your employer pays for it.
Currently, the IRS will allow your employer to pay for up to $50,000 of life insurance coverage for you, under an employer-provided group term life insurance plan, without taxing you for the benefit. However, if the coverage amount is higher than $50,000, you may be required to pay taxes on the amount over $50,000.
- Were your premiums paid with pre-tax or after-tax dollars?
When you buy life insurance on your own or through your employer, you’re probably paying with after-tax dollars – money on which your payroll taxes have already been deducted. If you buy insurance through a qualified retirement plan to which you make pretax contributions, however, you might be paying with pre-tax dollars. Knowing which you’re paying can help you make the best economic choices.
The estate planning attorneys at ILP can help you make smarter choices regarding both your coverage and your long-term financial plans. Please call us at (800) 827-7784 to explore your options.