Financial planning is something you never outgrow. If you've successfully planned for retirement, it may be time to start laying plans for estate planning to ensure your family and heirs are financially secure in the case you unexpectedly die. Life insurance is a key tool for many estate planners, though its impact on your current tax situation and your beneficiaries' taxes may be less clear than the need to carry life insurance policies. In general, the tax status that surrounds life insurance administered outside of annuities is usually straightforward.
Personal Policy Payments
Rather than rely on an employer to provide life insurance benefits, you may attend to your life insurance needs individually out of your own pocket. Although this strategy can benefit your family, it offers no immediate tax advantages, as the Internal Revenue Service prohibits individual taxpayers from claiming life insurance premiums as a miscellaneous expense. Treat policy payments as any other non-deductible bill, such as your telephone bill, and merely pay them and stop accounting for the cost, tax-wise. This non-preferential treatment ultimately aids beneficiaries.
While you don’t receive a tax deduction for funds spent on policy premiums, the IRS’s treatment of these payments simplifies taxation for whomever you name as a plan's beneficiaries. Because you already paid income taxes on the amount devoted to the premium in the year in which the you paid the premium, the IRS doesn’t double-tax the funds: Your beneficiaries don’t need to report life insurance payments on their Form 1040s, and receive this payment tax free. Your beneficiaries should report the policyholder as deceased by filing a final return for the policyholder with the IRS.
Corporate Policy Payments
If you're an employer and your company offers life insurance to your employees as part of their compensation package tax rules change slightly. Your company may claim life insurance payment costs in certain situations. For policies taken out after June 9, 1997 you may claim payments made on policies for your workers only if you're not directly or indirectly a beneficiaryof the policy, regardless of who the policy names as its beneficiary. Indirect benefit may be inferred as cases in which the beneficiary owes the you a debt. Additionally, if you name a business partner as a beneficiaries in a policy can’t deduct the premiums.
Inheriting an Annuity
Some companies structure annuities to name a secondary beneficiary in the case the primary one you named dies before the annuity contract comes due. In these cases, your secondary beneficiary may elect to receive a lump-sum payout of the annuity’s remaining value, severing the contract with the annuity provider. In this case, the lump-sum amount is not taxable. If your secondary beneficiary opts to continue receiving periodic payments from the annuity, the payments are taxable based on the type of annuity, either using the IRS's simplified method to determine its tax basis, or as regular taxable income.
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