Can Life Insurance Be Written Off on Taxes?

Life insurance serves as a financial tool designed to provide a protective layer for individuals and their families, offering a payout to designated beneficiaries upon the insured’s passing. This financial product helps ensure that loved ones receive support for expenses, maintain their lifestyle, or cover future needs. Many individuals commonly seek to understand how various financial commitments, including insurance premiums, interact with tax regulations, often inquiring about the possibility of “writing off” these costs. The tax implications of life insurance, however, are not always straightforward, varying significantly depending on the policy’s purpose and structure.

Personal Life Insurance Premiums

Premiums paid for personal life insurance policies are generally not considered tax-deductible for income tax purposes. The IRS views these payments as personal expenses, which do not qualify for deductions. This rule applies across different types of personal policies, including term, whole, universal, and variable life insurance.

Personal life insurance is not directly tied to income generation or business expenses. The cost of maintaining such coverage does not reduce an individual’s taxable income. This means premium payments do not reduce an individual’s tax liability in most personal scenarios.

Business-Related Life Insurance Premiums

The tax treatment of life insurance premiums can differ substantially when policies are integrated into business operations. Premiums for “key person” insurance, where a business insures a key employee or owner and is the beneficiary, are generally not tax-deductible. Although the premiums are not deductible, the death benefit received by the business upon the insured’s death is typically income tax-free.

Conversely, premiums paid by an employer for group term life insurance are often tax-deductible for the business as an ordinary and necessary expense. However, the cost of coverage exceeding $50,000 is considered taxable income to the employee. This imputed income is calculated using IRS-provided tables and must be reported by the employee.

For life insurance policies used to fund buy-sell agreements, premiums are typically not tax-deductible for the business or individual partners involved. This applies whether the policy is owned by the business itself or by the individual owners. While the premiums are not deductible, the life insurance proceeds received to facilitate the buyout are generally income tax-free to the recipient.

Split-dollar life insurance arrangements generally do not allow for premium deductibility. Tax implications primarily relate to the economic benefit transferred between parties, often employer and employee. The specific tax treatment depends on the structure of the arrangement and who owns the policy components.

Tax Treatment of Life Insurance Proceeds and Values

Beyond premium deductibility, life insurance policies offer distinct tax treatments concerning their proceeds and accumulated values. Death benefits paid to beneficiaries are generally income tax-free. An exception arises if the death benefits are held by the insurer and earn interest; any interest earned on these proceeds becomes taxable income to the beneficiary.

Permanent life insurance policies, such as whole life or universal life, accumulate cash value over time, which grows on a tax-deferred basis. Taxes on the growth are not due until the cash value is accessed. Policyholders can typically access this cash value through withdrawals or loans.

Withdrawals from the cash value are generally tax-free up to the amount of premiums paid into the policy, which is considered a return of principal. Any amount withdrawn exceeding the total premiums paid is considered taxable income. Loans taken against the cash value are typically tax-free, provided the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount exceeding the premiums paid can become taxable.

Accelerated death benefits, available to terminally or chronically ill individuals, are generally income tax-free. To qualify for tax-free treatment, specific IRS criteria for illness severity must be met; for chronic illness, benefits may be limited to qualified long-term care expenses. If the payments exceed certain per diem limits for chronic illness or if the insured does not meet the IRS definition of terminally or chronically ill, a portion may become taxable.

While death benefits are typically income tax-free to beneficiaries, they can be included in the deceased’s taxable estate if the insured retained “incidents of ownership” in the policy. Incidents of ownership refer to the right to change beneficiaries, surrender the policy, or borrow against its cash value. To remove life insurance proceeds from the taxable estate, individuals often use an Irrevocable Life Insurance Trust (ILIT) that owns the policy.

Donating a life insurance policy to a qualified charity can also have tax implications. If the charity is named as both the owner and beneficiary of the policy, the donor may be able to claim an income tax deduction for the lesser of the policy’s cash value or the total premiums paid. Subsequent premium payments made to the charity to maintain the policy may also be tax-deductible. This strategy can also remove the policy’s value from the donor’s taxable estate.