Is a life insurance payout taxable? Here's what you need to know

If you are the beneficiary of a life insurance policy, the payout — known as a death benefit — is typically tax-free. There are some exceptions, however.

Here's what you need to know about your tax liability if you receive proceeds from a life insurance policy.

Both whole life insurance and universal life insurance policies earn interest, referred to as cash value, and policyholders may be able to make withdrawals or take out a loan against the balance. If the withdrawal or loan is more than the total amount of premiums you've paid, the excess can be taxed.

MassMutual offers whole and universal life insurance up to age 60 or 90, depending on the policy. In 2023, it was one of JD Power's highest-ranking insurers for customer satisfaction and it received fewer complaints than expected for a company its size, according to the National Association of Insurance Commissioners.

If you cancel a whole life or universal life insurance policy, you typically receive the cash surrender value, which is your policy's cash value minus any fees. You don't have to pay taxes on the principal when it's returned, but any cash value your policy has accrued will be taxed as income.

Pacific Life offers a cash value enhancement rider that increases the cash surrender value of your policy if you need to cancel it within the first 10 years. The California-based insurer has a variety of cash-value policies, including indexed universal life insurance, which earns interest by tracking an index like the S&P 500, and variable life insurance, which allows the policyholder to directly invest in securities.

If you are receiving proceeds from an employer-paid life insurance policy, any death benefit beyond $50,000 is taxed as income, according to the IRS.

If you receive a policy payout in installments rather than as a lump sum, any interest that accrues is taxable. The principal death benefit is still not taxed.

If your estate is the beneficiary of your life insurance policy, the death benefit may be subject to estate taxes. In 2024, the federal estate tax ranges from 18% to 40%, depending on how much of the estate is over $13.61 million, the exclusion limit. for 2024 Without congressional action, the limit will revert to $5 million (indexed for inflation) at the start of 2026.

In addition to the federal tax, twelve states and the District of Columbia impose an estate tax, with the exemption limit ranging from $1 million in Oregon to $13.61 million in Connecticut.

If you've received a life insurance death benefit, that money can help solidify your financial future.

Pay off debt

A life insurance payout can chip away at high-interest debt like credit card bills and help raise your credit score. (On-time payments represent 35% of your credit score and the total amount you owe is another 30%.)

One way to address mounting card bills is a balance transfer to a card with a 0% introductory APR. The Wells Fargo Reflect® Card has no interest for 21 months from account opening on purchases and qualifying balance transfers (with a 17.74%, 24.24%, or 28.49% variable APR after that). balance transfers made within 120 days qualify for the intro rate, BT fee of 5%, min: $5.

An emergency fund

It's a good rule of thumb to save at least three to six months' worth of living expenses. It should be an account you can make penalty-free withdrawals from to handle a job loss, medical emergency, home repairs or other unforeseen cost.

Happen Bank's high-yield savings account has one of the highest yields we've reviewed and a free ATM card.

UFB Portfolio Savings HYSA has a 3.26% annual percentage yield and no monthly fee or minimum balance requirement. Policyholders get a free ATM card and can transfer between direct deposit accounts for free.

Save for retirement

An IRA is a great tool for building your nest egg: In 2024, you can contribute a total of $7,000 to all your IRAs (or $8,000 if you're 50 or older). Fidelity's IRA is a solid choice for beginners, combining an easy-to-navigate platform and a variety of investment options with no account fees or minimums.

If you want a hands-off investing experience, Betterment is CNBC's top choice for robo-advisors, allowing you to open a traditional or Roth IRA with as little as $10. There is also a premium plan for savers investing at least $100,000 with unlimited access to certified financial planners.

While life insurance benefits are typically not taxed, there are some circumstances when a payout can expose you to tax liability, including receiving it in installments.

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