Is Whole Life Insurance Tax Deductible?

Whole life insurance is a form of permanent life insurance with a death benefit and a cash value savings account. For individual taxpayers, premiums for a whole life policy are not tax-deductible. The Internal Revenue Service (IRS) classifies these payments as a personal expense, much like auto or home insurance, and they do not qualify for a deduction. This rule applies even to self-employed individuals.

Tax Treatment for Individual Policyholders

While premiums do not offer a tax advantage, the policy contains other features with beneficial tax treatments. A feature of whole life insurance is the tax-deferred growth of the cash value component. As you pay premiums, a portion funds the policy’s cash value, which grows over time without being subject to annual income taxes, allowing the funds to compound more effectively.

Policyholders can take out loans against their policy’s cash value. These loans are not considered taxable income, provided the loan amount does not exceed the total premiums paid into the policy, known as the policy basis. If you make a withdrawal or surrender the policy, any amount you receive that is greater than your policy basis is subject to income tax.

The most well-known tax advantage of life insurance is the treatment of the death benefit. When the insured person passes away, the death benefit is paid to the named beneficiaries. These proceeds are received free of federal income tax and do not need to be reported as gross income.

Business-Related Premium Deductions

While individuals generally cannot deduct whole life insurance premiums, businesses may be able to under specific circumstances. The deductibility depends entirely on the purpose of the insurance and who benefits from the policy. These rules are designed to prevent businesses from gaining an unfair tax advantage while still allowing for legitimate business-related insurance expenses to be recognized. The context of the policy’s ownership and beneficiary designation is central to the IRS’s determination.

One business use is “key person” insurance, where a business purchases a policy on the life of a crucial employee. If the business is the beneficiary of the policy, the premiums are not tax-deductible. Since the business stands to receive a tax-free death benefit, it cannot also deduct the premium costs, which prevents a double tax benefit.

A business may deduct premiums if a life insurance policy is used as collateral to secure a loan. For the deduction to be allowed, the policy must be required by the lender as collateral. The business cannot be a beneficiary under the policy, as the lender would have first claim to the proceeds to satisfy the debt.

Employers often provide life insurance to their employees as a benefit. When an employer pays for group-term life insurance for its employees, the premiums are generally deductible as a business expense. However, there are limits to this benefit from the employee’s perspective. The cost of the first $50,000 of coverage is typically excluded from the employee’s income. If the employer provides coverage exceeding $50,000, the cost of the excess coverage, as calculated by an IRS table, must be included in the employee’s taxable income.

Special Circumstances for Deductibility

Beyond standard individual and business uses, a few niche situations exist where whole life insurance premiums could be deducted, though recent tax law changes have altered one of these scenarios significantly. These circumstances are not common but are important to understand for those to whom they might apply. They involve legal agreements such as divorce decrees and charitable giving strategies.

For divorce or separation agreements executed on or before December 31, 2018, the spouse paying the premiums could deduct them as alimony, provided the policy ownership was transferred to the ex-spouse who was also the irrevocable beneficiary. The Tax Cuts and Jobs Act of 2017 eliminated the alimony deduction for any agreements executed or modified after that date. For these newer agreements, premiums paid are no longer deductible.

Another special circumstance involves charitable giving. A policyholder can donate their whole life insurance policy to a qualified charitable organization. To do this, the donor must transfer complete ownership of the policy to the charity, making the charity the irrevocable beneficiary. Once the transfer is complete, any subsequent premium payments made by the original owner are considered charitable contributions and may be deductible, subject to the standard rules and limits for such donations.