63 / Are life insurance proceeds payable by reason of the insured’s death taxable income to the beneficiary?
Generally, no. As a general rule, death proceeds are excludable from the beneficiary’s gross income.1 Death proceeds from single premium, periodic premium, or flexible premium policies are received income tax-free by the beneficiary regardless of whether the beneficiary is an individual, a corporation, a partnership, a trustee, or the insured’s estate.2 With some exceptions (as noted below), the exclusion generally applies regardless of who paid the premiums or who owned the policy.
Note that death proceeds from certain employer-owned life insurance contracts received by the employer as beneficiary will not be excluded from the employer’s taxable income unless certain requirements are met ( Q 8776).3
Planning Point: When presenting a key person proposal it is important to ask the prospect, “How much additional gross sales would it take to equal the income-tax-free benefits of life insurance?” Also point out that the sales revenue will be needed at a time when the business has lost a person critical to the creation of that revenue. William H. Alley, CLU, ChFC, MSFS, LUTCF, Alley Financial Group, LLC.
Proceeds from group life insurance can qualify for the exclusion as well as proceeds from individual policies. Under certain conditions, accelerated death benefits paid prior to the death of a chronically or terminally ill insured may qualify for this exclusion ( Q 54). On the other hand, death benefits under annuity contracts do not qualify for the exclusion because they are not proceeds of life insurance within the meaning of IRC Section 101(a)(1).
In order to come within the exclusion, the proceeds must be paid “by reason of the death of the insured.” In other words, the exclusion applies only to proceeds that are payable because the insured’s death has matured the policy. When the policy has matured during the insured’s lifetime, amounts payable to the beneficiary, even though payable at the insured’s death, are not “death proceeds.” Proceeds paid on a policy covering a missing-in-action member of the uniformed services were excludable, even though no official finding of death had been made by the Defense Department.4