Taxation of Life Insurance Benefits

[dios.del.sol]

I'm planning out my life insurance policy and in running the numbers I realized I have no experience with taxes in this realm. A quick web search tells me that they are not taxed as income to the beneficiary, but that they could be subject to the estate tax (if I both die and own the policy). Is this generally correct? Are there any common pitfalls to avoid? Tricks of the trade?

[FIPurpose]

So my quick google search shows that California does not have an estate tax. And the national estate tax begins at $5M. If your net worth isn't close to that, it probably isn't worth worrying about.

[JoJo]

Very rarely are they subject to estate tax.

[mxt0133]

If they pay directly to someone designated as the beneficiary then it bypasses estate taxation, this is why wealthy people use them as wealth transfer vehicles even if they are poor investment vehicles.  If your beneficiary has passed away then the funds belong to your estate and is subject to estate taxes.

[dios.del.sol]

Clearly I'm too po' for this to be relevant. Fascinating nonetheless. Thanks for enlightening me.

[DK]

If you are buying it, paying it with after tax money - it is not taxed. If its company sponsored insurance policy, it would be taxed.

[socaso]

My father was an insurance agent and when we bought our life insurance policies 3 years ago he told me life insurance is not subject to taxes. To be fair, he might have meant specifically in our situation which is one spouse leaving the policy to another spouse. Also funny side note, when we signed up for the policies we found out that in California if you leave a policy to someone who is not your spouse and you are married you have to have your spouse sign a form stating they are aware of this. Cheaters, beware, I guess.

[cynthia1848]

If you individually own the policy, it would be subject to estate tax.

I have my clients hold their life insurance through an insurance trust.  Gifts to the trust to pay the premium are subject to gift tax but the death benefit will not be subject to estate tax.  You are correct that depending on your state, you may not need to worry about it.  Fed estate tax exemption this year is $5.34M per person.

[chucklesmcgee]

To be fair, he might have meant specifically in our situation which is one spouse leaving the policy to another spouse.

Probably not, as ALL property left to a surviving spouse is not subject to federal estate taxes.

[frugaldrummer]

I have no idea what current tax law is, but many moons ago when I was married and we were buying life insurance, I remember our agent structuring the policies so that I paid for the policy on my spouse's life and vice versa. Apparently there was some favorable treatment if you were the one who actually owned and made the payments on the policy?