Is life insurance taxable?

[00:00:00] Ralph Estep, Jr.: So here's today's question, and it's really pretty simple: is your life insurance taxable? Now, the answer might just surprise you. Picture this: you just lost a loved one. And I know that's a tough thing. In the midst of that grief, you're hit with an unexpected tax bill on their life insurance payout. But don't let this happen to you because today we're diving into the world of life insurance taxation, and I'm going to share some eye-opening stories that could save you and your family from a financial headache.

[00:00:31] Ralph Estep, Jr.: So stay tuned to find out how this could impact your financial future as I answer the simple question: is your life insurance taxable?

[00:00:45] Ralph Estep Jr.: Now, before we get started today, let me just remind you about what we talked about yesterday. It was a great episode from the perspective of a teller.

[00:00:54] Ralph Estep Jr.: It was those 10 things that banks don't want you to know that could cost you money. So if you missed it, head over to askralph.com. Trust me, you don't want to leave that money on the table.

[00:01:07] Ralph Estep Jr.: Well, let's get to today's topic. I received this message from Fiona. She wrote this: "Dear Ralph, my husband and I just recently started thinking about life insurance. We want to make sure our kids are taken care of if anything happens to us. But we're worried about the tax implications. Are life insurance payouts taxable? How can we make sure our beneficiaries get the full amount?" Well, Fiona, thank you so much for this important question. It's one that many people overlook, and I'm glad you're thinking about it today.

[00:01:40] Ralph Estep Jr.: I am thrilled you joined me today. Your trust in the show means the world to me. I am committed to providing you with the knowledge and insights you need to achieve financial freedom while growing in your faith.

[00:01:55] Ralph Estep Jr.: Well, let's ground ourselves in scripture, as we always do, with some wisdom.

[00:02:03] Ralph Estep Jr.: And this one comes from the book of 1 Timothy 5:8, and it says this: "Anyone who does not provide for their relatives, and especially for their own household, has denied the faith and is worse than an unbeliever." Whew, man! Now that one will cut you. But it reminds us of the responsibility we have to take care of our loved ones. Part of that is making wise financial decisions, and part of that is understanding life insurance.

[00:02:34] Ralph Estep Jr.: Now let's tackle Fiona's question about life insurance. Brace yourself, because the answer might not be what you expected. Well, let me tell you a story about how I look at this.

[00:02:45] Ralph Estep Jr.: It really changed the way I look at things. It was a crisp autumn morning, and I get this call from one of my clients. And let me tell you, this call will stick with me. On the other end of the line was my client—I'll call him John—and I could tell something was wrong with John. His voice was just trembling with emotion. He told me he had just lost both of his parents in a terrible auto accident. And I sat there...

[00:03:08] Ralph Estep Jr.: You know, my heart was breaking for him. I'm listening to John, and he's telling me all about what's going on, and I... you know, it made me think about it, not in financial terms. It made me think about the fragility of life and how we all need to be prepared for these unexpected things. So John was not only dealing with the overwhelming grief of losing both of his parents at the same time, but suddenly, John was in charge of their financial affairs. He had to manage what happened in the aftermath. So here's where things took an interesting turn. Now, the good news is John's parents had great foresight and had purchased substantial life insurance policies. And John, being the only child, was named as the sole beneficiary. So, after we got past the grief part, John and I sat down and started looking at the details. And one day, John asked me a simple question.

[00:03:56] Ralph Estep Jr.: He said, "Ralph, will I have to pay taxes on this insurance payout?" Now, as he said it, I could hear his voice. He was tensed up; he was so worried about it. And I just said to him, "No, John, in most cases, life insurance proceeds are not taxable." Well, you could see the relief on his face. I mean, you could tell in his voice that that was one less thing he had to worry about. But this is the crucial point, and I want you to remember this. I want to say this: generally speaking—and I use the word 'generally' because there are always situations when it's not the case—life insurance payouts are not taxable income to the beneficiary. So, if you're the receiver of a life insurance policy, generally, it's not going to be a taxable event for you. And it's one of the few ways that you can transfer a large sum of money to your loved ones without having Uncle Sam take their cut. But here's where it gets a bit interesting. Now, John's situation was pretty straightforward. His mom and dad both passed away, they had life insurance policies, and he was the sole beneficiary of them. But not all scenarios with insurance are created equal. So let me share another story that talks about the importance of proper planning and communication. And this one comes from a client.

[00:05:04] Ralph Estep Jr.: Her name was Mary. Now, her father had recently passed away. And the thing is, her father always told her, "Mary, when something happens to me, I've got a life insurance policy," but he never shared any of the details with her. And now, it became a problem. It became this frustrating, time-consuming process trying to track down the policy so that Mary had proof to claim it.

[00:05:27] Ralph Estep Jr.: Truth be told, we had to play detective. We had to comb through her father's old documents. We contacted various insurance companies trying to figure out who had this information. We finally were brought to our attention that there was this thing called the National Association of Insurance Commissioners' Life Insurance Policy Locator.

[00:05:44] Ralph Estep Jr.: So we were able to use that service, and it took months—I'm talking months of detective work—combing through his details. We were looking at his bank statements; we were looking at where he was making payments to. But we finally found the policy, and Mary was finally able to get her payout. And this experience taught me two valuable lessons that I want to share with you today. Number one: always keep your beneficiaries informed about your life insurance policy.

[00:06:10] Ralph Estep Jr.: You’ve got to let them know the company, let them know the policy number, and where to find those documents. If you have a policy, your whole purpose in doing it is you want to provide for them. Well, you’ve got to provide for them the details so that when something does happen to you, they can go collect on that policy.

[00:06:26] Ralph Estep Jr.: Another thing: this is a must-do. You've got to regularly review and update your beneficiary designations. The truth is, life changes, and your insurance should reflect those changes. Maybe you've had a new grandchild that you want to name as a beneficiary. Unfortunately, maybe you had a child that passed away or some life change happened.

[00:06:43] Ralph Estep Jr.: Maybe you went through a divorce. But this is a big deal, and it's something that you've got to keep track of. So, number one: keep your beneficiaries informed, and number two: make sure those things are updated. Well, I'll circle back to the tax issue because there are some situations where life insurance proceeds might be taxed.

[00:07:00] Ralph Estep Jr.: Well, that's why I said 'generally.' So, I'm going to talk about some exceptions. The first exception is this: interest. If the insurance company holds the payout for a period and then pays interest, that interest is taxed. You’re going to get a 1099-INT at the end of the year. Now, the actual proceeds from the life insurance policy are not taxable, but if it earns interest while they're holding the money—maybe they're doing an investigation,

[00:07:25] Ralph Estep, Jr.: making sure that everything's in order, and there's interest being collected on that—you’re going to have to pay tax on that interest. Now, there also could be a situation if you have an employer-provided policy. Now, employers are generally able to pay for your life insurance and death benefit up to $50,000, but once it goes over $50,000, you might owe tax.

[00:07:44] Ralph Estep Jr.: That’s why, when you get your taxes done, and you hand them to somebody like myself, with your W-2, sometimes you may have heard your tax preparer or your accountant say, "Okay, I see that you have employer-sponsored life insurance," and that becomes taxable income. So, you're going to pay tax on it as you go.

[00:08:00] Ralph Estep Jr.: Another thing to be aware of is estate taxes. This is if the policy pushes your life insurance policy over the federal tax exemption limit. Now, right now, it's 12 and a half million dollars. I don't know too many people who’ve got a 12 and a half million-dollar life insurance policy, but if you find yourself, or if you know politics change and this amount—this exemption—is something that I've heard they’ve talked about in the current election... be aware of that. But that could cause an estate tax issue.

[00:08:35] Ralph Estep Jr.: And number four, and this is what we call transfer of value. So, if you sell your life insurance policy to someone else, those proceeds may become partially taxable. Those are all scenarios where you want to meet with someone like myself or an attorney and understand what's going on. So, I want to give you some action steps. I always like to give you things that you can do.

[00:08:52] Ralph Estep Jr.: Here's what you want to do: You want to make sure your beneficiaries are up to date, and they know about the policy, just like we ran into with Mary. If you've got a large estate, you want to consult with a tax professional to ensure you're not inadvertently creating a tax burden for your heirs. That's the last thing you want to do. And remember this: life insurance is meant to provide financial security for your loved ones. So, if you understand these tax implications, you can ensure your policy does exactly what you intend for it to do.

[00:09:18] Ralph Estep Jr.: Listen, if you hide it in a drawer and nobody knows about it, all of your intentions of providing this life insurance policy are of no consequence because they can't find it. And you want to make sure you've named beneficiaries. And if you've gone through a divorce, maybe you've lost a child who was a named beneficiary, or something like that, you've got to make sure you're keeping those things up to date because you don't want a huge nightmare like Mary went through, trying to track down this life insurance policy. Sometimes, listen, here's a bigger issue. I have had situations where they've never been able to find a life insurance policy because sometimes these life insurance policies were paid for years in advance because they were, you know, making a whole life policy that just paid for itself moving forward.

[00:10:00] Ralph Estep Jr.: Well, let me wrap up with a few key points—easier for me to say than you! In most cases, life insurance proceeds are not taxable to the beneficiary, as we've discussed that in most cases. And again, I want to remind you: always inform your beneficiaries about your policies and keep those designations updated. You also need to be aware of any exceptions where life insurance might be taxable.

[00:10:24] Ralph Estep Jr.: That's when you want to meet with your attorney, with your accountant, with somebody professional, and always—I'll stress this ten times today—you've got to regularly review your policies and consult with professionals if you've got that large estate. Well, thank you for tuning in to our Tax Talk Thursday.

[00:10:39] Ralph Estep Jr.: Now, tomorrow, I'm going to be taking a little bit of a Financial Friday dive, and we're going to be talking about what are the best money lessons to teach your kids. It's a topic that's close to my heart. My kids are 23 and 27, so I can't wait to share some practical advice that could shape your children's financial future.

[00:10:56] Ralph Estep Jr.: As a little bit of a prelude, we're going to be talking about jars on the floor for toddlers. Now listen, before we go, I want to remind you: I'm here to help you. I'm here to help you personally with your finances. If you're feeling overwhelmed by your finances, or maybe you're ready to take your financial life to the next level, I'm going to encourage you to schedule an appointment with me.

[00:11:14] Ralph Estep Jr.: I charge $150 for a consultation fee. You're going to get that back three times in value. I can work with you to improve your personal financial situation. I can help you boost your business, grow your business. But my overall goal is to help you achieve all of those financial goals, those dreams, and those aspirations. So, when you're ready to take the plunge, I'm going to encourage you to do it right now.

[00:11:36] Ralph Estep Jr.: Head over to askralphpodcast.com/store and book your consultation. We're going to work together to do a personalized plan that sets you on the path to financial success. And more importantly than that, not just financial success, but peace of mind. And remember this: my passion is to help you achieve financial success.

[00:11:56] Ralph Estep Jr.: I want you to live out your dreams. I want you to grow in your faith at the same time. And I know, working together, we can master your finances from that Christian perspective. So, as I always say, stay financially savvy, and God bless you.