Over the years Congress has included many provisions in the tax code that gives life insurance important income tax and transfer tax benefits. These tax benefits can add to the financial security and flexibility life insurance provides to policy owners and beneficiaries.
Federal Income Tax Benefits
- Death Benefits
- Policy death benefits are usually paid to beneficiaries income tax-free.1 IRC Section 101(a).
- Benefits paid out before the insured’s death because of chronic or terminal illness are tax free. IRC Section 101(g)1.
- Policy Cash Values
- Cash values can grow within the policy without being subject to tax. IRC Section 72
- Withdrawals up to the amount of the policy owner’s tax basis are not subject to income tax.2 IRC Section 72
- Cash values exceeding the owner’s tax basis may be borrowed from the policy income tax free as long as the policy stays in force.2 IRC Sections 72 and 7702
- Tax-Free Exchanges
- The owner may exchange an existing for a new one free of income taxes. IRC section 1035.
- The owner may exchange a life insurance policy for an annuity free of income taxes. IRC Section 1035
Federal Transfer Tax Benefits
Life insurance policies transfer wealth to beneficiaries through the death benefits paid out when an insured dies. Over the years Congress created the federal estate, gift and generation skipping transfer taxes to the Internal Revenue Code to tax and regulate the transfer of wealth. Each of these taxes gives insureds opportunities for life insurance to pass on wealth to family members with favorable results:
- Estate and Generation Skipping TransferTaxes—
- Death benefits paid to a surviving spouse who is a US citizen qualify for the marital deduction and aren’t taxed. IRC Section 2056
- Death benefits payable to others aren’t part of the taxable estate if the insured did not have an incident of ownership in the policy at any time within the three years before death. IRC Sections 2042 and 2035
- Gift Taxes—
- Premiums paid by the policy owner aren’t treated as taxable gifts.
- Funds an insured gives to someone else who owns the policy can avoid gift taxes if they qualify for the gift tax annual exclusion or the lifetime gift exemption.
Variable insurance products are subject to investment risk, are not guaranteed and will fluctuate in value. In addition, there is no guarantee that any variable investment option will meet its stated objective.
These materials are not intended to and cannot be used to avoid tax penalties and they were prepared to support the promotion or marketing of the matters addressed in this document. Each taxpayer should seek advice from an independent tax advisor.
Neither Voya nor its affiliated companies provide tax or legal advice. Please consult with your tax and legal advisors regarding your individual situation.
1Proceeds from an insurance policy are generally income tax free and if properly structured, may also be free from estate tax.2Income tax free distributions are achieved by withdrawing to the cost basis (premiums paid) then using policy loans. Loans and withdrawals may generate an income tax liability, reduce available cash value and reduce the death benefit or cause the policy to lapse.