Is Life Insurance Taxable? – Forbes Advisor INDIA

The primary purpose of life insurance is to provide a death benefit that can take care of your loved ones financially. A bonus is that life insurance death benefits aren’t typically taxed. Since coverage amounts can be very high—into lakhs—it’s a significant advantage that the life insurance payout is tax-free.

But some aspects of life insurance won’t get past the taxman.

Is a Life Insurance Payout Taxable?

Life insurance death benefit payouts are usually not taxable for the beneficiaries. That means beneficiaries will receive the money without a tax burden hanging over their heads.

However, there are certain situations where a life insurance death benefit may be taxable. Here’s a look at when to prepare for a tax bill.

You Are a Life Insurance Beneficiary Who Receives Interest on a Death Benefit

Most life insurance payouts are made in one lump sum right after the death of the insured person. But if a beneficiary chooses to delay the payout or take the payout in installments, interest may accrue. In that case, the interest paid to the beneficiary may be taxed.

The Life Insurance Payout Goes Into a Taxable Estate

Most life insurance payouts are made tax-free directly to life insurance beneficiaries. But if a beneficiary was not named, or is already deceased, where does the life insurance death benefit go? It goes into the estate of the insured person and can be taxable along with the rest of the estate.

The life insurance payout itself is typically tax-free; complications arise when the person has no beneficiary or if the beneficiary is deceased. The payout goes into the insured person’s estate, and any income from this amount might be taxable. We recommend consulting a legal advisor or tax professional for specific advice.

The Life Insurance Policy Involves Three Different People

Life insurance death benefits can become a taxable gift in a situation where three people serve three different roles in connection with the life insurance policy. The positions include:

• The policy owner. This is the person who purchased the policy and is ultimately responsible for paying the premiums.
• The insured. This person’s life is covered by the life insurance policy.
• The beneficiary. This person receives the death benefit when the insured person dies.

In India, death benefits are typically tax-free under Section 10(10D) of the Income Tax Act. There is no yearly or lifetime gift exclusion limit for tax purposes, but gifts from non-relatives that exceed INR 50,000 can be taxable under certain circumstances.

Is the Cash Value in a Life Insurance Policy Taxable?

If you have a cash value life insurance policy, like whole life insurance, you can generally access the money through a withdrawal, a loan or by surrendering the policy and ending it.

One of the reasons to buy cash value life insurance is to have access to the money that builds up within the policy. When you pay premiums, the payments generally go to three places: cash value, the cost to insure you and policy fees and charges. Money within the cash value account grows tax-free, based on the interest or investment gains it earns (depending on the policy). But once you withdraw the money, you could face a tax bill.

Money that’s withdrawn from cash value is generally made up of two parts:

If your life insurance policy is a “modified endowment contract,” or MEC, different tax rules apply and it’s best to consult a financial professional to understand tax implications.

Here are situations where cash value may be taxable.

You Surrender the Life Insurance Policy

There can be times when a policy owner no longer wants or needs the life insurance policy. You can take the surrender value of the life insurance policy and the insurer will terminate the coverage. The amount you receive is your cash value minus any surrender charge. You can generally expect to get a surrender charge within the first 10 or 20 years of owning the policy, and over time the surrender charge phases out.

You won’t be taxed on the entire surrender value, though. You’ll be taxed on the amount you received minus the policy basis, or the total premium payment you made on the policy. This taxable amount reflects the investment gains that you took out.

Say the premiums you’ve paid over many years add up to INR 38,000 and your total cash value is INR 45,000. The portion of the payout that would be taxed is INR 7,000, representing the investment gains.

You Took Out a Policy Loan and the Life Insurance Ends

If you have a policy with cash value and take a life insurance policy loan against it, the loan isn’t taxable—as long as the policy is in force. But if the policy terminates before you’ve paid the loan back, you could get a tax bill. For example, the coverage terminates if you surrender the policy or it lapses.

The taxable amount is based on the amount of the loan that exceeds your policy basis. Policy basis is the portion you’ve paid in premiums. Amounts “above basis” are based on interest or investment gains on cash value.

One way to access all your cash value and avoid taxes is to withdraw the amount that’s your policy basis—this is not taxable. Then access the rest of the cash value with a loan—also not taxable.

If you die with a loan against the policy, the death benefit is reduced by the outstanding loan amount.

You Sell the Life Insurance Policy

You are surrendering your life insurance policy to receive its cash value, which may be subject to possible taxation on any gains. Selling a life insurance policy to another party is not a usual practice and needs to be better regulated. The tax implications of surrendering or selling a policy depend on the value received and whether it exceeds the policy basis.

Summary: When Is Life Insurance Taxable?