Is Life Insurance Tax Deductible?

Julie Kiley is the vice president of High-Net-Worth Tax Planning at Northwestern Mutual.

Life insurance can be an important part of your financial planning—and when it comes to money, taxes are often on our minds. So, let’s explore the ins and outs of life insurance and taxes.

Are life insurance premiums tax deductible?

Usually life insurance premiums aren’t tax deductible. From the perspective of the IRS, paying for your life insurance is like paying for personal cell service—there’s no income tax deduction on the payments you make.

But there are some exceptions, including these:

• Businesses that offer certain types of life insurance as an employee benefit may be able to deduct premiums.
• The premiums for life insurance specified in an alimony agreement may be tax deductible if the agreement is dated before 2019 and if certain conditions are met.

Below, we share some details about the two main exceptions listed above.

Business-paid premiums may be tax deductible

Businesses may not deduct life insurance premiums if the business is directly or indirectly a beneficiary of that policy. But in three different situations, businesses can receive tax benefits for the group term life insurance premiums they paid. (Group term life is offered to several people, such as a company’s employees. They get coverage under a single policy for a certain term, which often ends for each covered individual when their employment ends.)

1. Businesses may be able to deduct premiums on group term life coverage up to $50K per employee if the business is not a beneficiary—most often, the employee should be the owner of that policy.
2. Business-paid premiums for policies with coverage exceeding $50K may be deductible if the employee reports the premium as income. This doesn’t apply to shareholders of 2 percent or greater of an S corporation.
3. But life insurance premiums paid for shareholders who own 2 percent or more of an S corporation may be deductible as compensation. The entire premium—not just the portion exceeding $50K in coverage—will need to be added to the shareholders’ taxable income.

Sole proprietors often wonder if they can count life insurance premiums as business expenses on their Schedule C (Form 1040). The IRS usually doesn't allow life insurance premium payments as a deduction for sole proprietors.

Business owners should consult their tax advisors before attempting to deduct life insurance premiums.

Life insurance required as alimony may be tax deductible

Another exception involves a divorce or separation. The agreement sometimes specifies that life insurance must be provided as alimony. If a divorce or separation agreement was finalized before 2019 and requires one spouse to pay life insurance premiums on their life for the benefit of the other spouse, then it may be deductible as alimony. The other beneficiary spouse must own the policy, include the same premiums as income, and be sure the terms meet other specific “alimony” requirements.

Consult your tax advisor if you think this exception applies to you; it applies only under specific conditions, and the rules are complex. You can also talk with your tax advisor to understand the other ways that a divorce may affect your taxes.

Some policies donated to charity may be tax deductible

Another exception involves a donation to a nonprofit organization. Let’s say you have a type of insurance called “permanent life insurance,” but your beneficiaries won’t need the death benefit upon your passing. For example, maybe your children have grown up, and you’ll leave them other substantial assets. You might decide to donate your policy to charity by making the nonprofit the new owner and beneficiary. You may get a tax write-off or charitable tax deduction equal to either the fair market value of the policy or the amount you paid into it, whichever is less.

This tax benefit could be particularly helpful if you need to offset a large tax bill one year—but remember that your estate, trust or beneficiaries will lose out on what would often be a tax-free inheritance. It’s something to consider carefully, as your estate may need the funds to pay taxes or other final expenses. And keep in mind that once the policy is gifted to charity, you won’t be able to access the policy’s cash value that may have otherwise been available to you.

The rules are complex and specific, so work with your tax advisor and financial planner if you’re considering donating your policy to charity for the tax deduction. You’ll also want to make sure the charity accepts life insurance policies as donations and has the staff and funds to manage the policy.

More tips about taxes and life insurance

Although premiums typically aren’t tax deductible, life insurance can be a helpful tool for managing the impact of taxes as a part of your broader retirement tax strategy. This is especially true for people whose estate will likely be subject to estate tax or for people who think their estates or loved ones will need cash to manage final expenses. While the details can sometimes be a little complicated, your financial advisor and tax professional can help you understand how everything works. Together, you can find the best solution for your situation.

Permanent life insurance cash value may be tax deferred

In addition to coverage for your entire life, permanent life insurance policies have a cash accumulation component. Cash value in certain types of permanent life insurance policies will grow over time, and taxes on the growth are deferred. Some of the most common types of life insurance policies where this can be the case include:

• Whole life.
• Variable life.¹
• Universal life (including variable universal life¹).

Once you accumulate cash value, you can use it for anything you want. You might, for example, use a life insurance loan to borrow against your cash value and then use the proceeds of that loan to help pay for college, a downpayment on a house or even to make your premium payments.² Consult your tax advisor if you are planning to access the cash value in your policy and aren’t sure of the tax consequences.

Permanent life insurance dividends are typically tax-free

Generally, cash dividends³ are also tax-free and don’t need to be reported as income. That’s true as long as the amount doesn’t exceed the net premiums you’ve paid on the policy. After that, you may need to pay federal and state taxes.

Life insurance death benefits are usually tax-free

Another huge tax advantage for your loved ones is that a life insurance death benefit payout is typically tax-free because that payout usually isn’t considered income. But if your family chooses to spread the payments out over time instead of receiving it as a lump sum—and the insurance company then adds interest—those interest payments will be taxable.

Different rules for taxes on an inheritance

Keep in mind that the tax rules for the payout from life insurance can work differently from other taxes on an inheritance. A person’s estate and the family’s inheritance may follow rules under the estate tax laws, and some states also have their own estate tax or an inheritance tax. These are the taxes charged when someone’s property, possessions and financial holdings are transferred upon their death and exceed a certain limit or meet certain criteria. Your financial advisor, an estate planning attorney and a tax advisor can help you build a plan to minimize estate taxes and related estate income taxes.

Your financial advisor can help you understand your options

Life insurance and taxes can both be complicated subjects. Your Northwestern Mutual financial advisor can help you understand your coverage options to ensure you’re making the right choices for your situation. They can also review your financial plan to look for opportunities and blind spots that you might otherwise overlook, for retirement planning or overall financial planning.

This publication is not intended as legal or tax advice. Financial representatives do not give legal or tax advice. Taxpayers should seek advice based on their particular circumstances from an independent tax advisor.