Life insurance can be a valuable addition to your financial plan. If you have a family, for instance, purchasing a policy can provide financial peace of mind in case something happens to you. Your beneficiaries can receive a death benefit, which is typically free from income tax. But are life insurance premiums tax deductible? For most people, the answer is no. But it’s important to understand when life insurance premiums can qualify for a tax deduction. One of the wisest moves you can make as you develop a tax strategy is working with an experienced financial advisor.
What Is a Life Insurance Premium?
When someone purchases a life insurance policy, they’re effectively purchasing a future benefit. If you buy a life insurance policy for yourself, for example, it may be with the intention of leaving behind a death benefit for your spouse, children or someone else. When you pass away, the life insurance company pays out that benefit to the beneficiary or beneficiaries you named in the policy.
In exchange for this future benefit, you pay a premium to the life insurance company. Life insurance premiums are typically paid on a monthly basis, though you may pay them quarterly, semiannually or annually. The amount you pay for a life insurance premium can depend on several things, including:
Size of the policy (i.e. the death benefit)
Policy term (i.e. 10 years, 20 years or 30 years)
Policy type (i.e. permanent or term)
Your overall life insurance risk profile
Life insurance companies can look at a person’s age, gender, occupation, hobbies and overall health to determine whether to approve them for a life insurance policy. Those same factors can also influence the premiums you pay.
As a general rule, the younger and healthier you are when you purchase life insurance the lower your premiums tend to be. Term life insurance policies can also offer lower premiums than permanent policies, as you’re only being covered for a set time period versus your entire lifetime.
Are Life Insurance Premiums Tax Deductible?
One of the biggest advantages of purchasing life insurance is that death benefits paid to beneficiaries are usually tax-free. This means you can leave some financial security behind for your loved ones without worrying that they’ll be stuck with a large tax bill.
But you may be wondering if you can gain a tax break for yourself during your lifetime by deducting life insurance premiums. The short answer is most often going to be no, life insurance premiums are not tax deductible if you’re buying a policy for yourself or another family member. That’s because the IRS views life insurance as a personal expense.
There are, however, some exceptions when you may be able to write off life insurance premiums on your taxes.
Divorce. If your divorce decree or alimony agreement requires you to purchase and maintain life insurance for a former spouse and it went into effect prior to 2019, you could still deduct those premiums on your taxes.
Business ownership. If you run a business and purchase life insurance for your employees as part of a benefits package, you may be able to deduct premiums as long as your company doesn’t benefit from the policy in any way.
There are some additional rules to know for business owners. First, premiums are only deductible if life insurance coverage doesn’t exceed $50,000. Premiums paid for policies above that amount have to be treated as employee wages so you can’t write them off on your taxes.
You also can’t deduct premiums paid for life insurance policies for a spouse if they’re an employee of the business and you’re the policy’s beneficiary. Deductions aren’t available for self-employed business owners either since you’re paying for your own coverage. Though you could still deduct health insurance premiums you pay out of pocket.
What Are the Tax Benefits of Life Insurance?
The key tax benefit associated with life insurance is the tax-free payments made to beneficiaries when the insured person passes away. Additionally, you typically won’t pay any taxes on your policy during your lifetime which can balance out not being able to claim a tax deduction. There are, however, a few scenarios where a life insurance policy could become taxable to you.
You sell the policy. If you decide to sell a life insurance policy you no longer need, any profits you make from the sale are considered taxable income by the IRS.
You withdraw cash value from the policy. Permanent life insurance policies can allow you to accumulate cash value over time as you pay in premiums. This money can grow tax-deferred but if you withdraw earnings from the policy, you’ll pay taxes on them.
You surrender the policy. Surrendering a permanent life insurance policy allows you to get its equivalent in accumulated cash value. But if you’re getting earnings from the policy, that’s taxable income.
Death benefits are paid in installments. It’s typical for life insurance death benefits to be paid in a lump sum. But if your beneficiaries choose to receive installment or annuity payments instead, they may owe taxes on any interest or earnings the policy accrues.
How to Buy Life Insurance
If you don’t have life insurance yet, it’s important to consider what kind of coverage you may need when comparing quotes. For example, if you’re married with kids you might want to have a policy that’s large enough to pay off any debts and provide money for day-to-day expenses should something happen to you. On the other hand, you may only need a smaller policy if you’re single and want to leave behind enough money to cover your final expenses.
You’ll also need to consider whether a permanent or term life insurance policy makes more sense. Permanent coverage remains effective for as long as premiums are paid. So you could use this type of policy to get covered for life. Some permanent life insurance policies allow you to build cash value which you could borrow against or invest to grow wealth.
The trade-off, however, is that permanent life insurance tends to have higher premiums compared to term life. With term life, you’re only covered for a set time period. So if you’re 30 years old you might purchase a 20 or 30-year term policy. You won’t get any cash value accumulation but you may pay less in premiums overall.
Talking to an insurance agent or your financial advisor can help you figure out which type of policy is best for meeting your needs. You can also discuss any potential tax breaks that may be gained from purchasing life insurance for your employees if you run a business.
The Bottom Line
Are life insurance premiums tax deductible? No, unfortunately. At least, not for most people who are purchasing coverage for themselves or a loved one. But that shouldn’t deter you from purchasing life insurance if it’s something you need in your financial plan. Taking time to calculate your coverage needs and shop around for the best life insurance companies can help you find the right policy.
Life Insurance Tips
Consider talking to a financial advisor about purchasing life insurance how to choose an appropriate policy option. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor, get started now.
One of the fastest ways to get a good estimate of how much life insurance you need is by using our free calculator.
Photo credit: ©iStock.com/razerbird, ©iStock.com/Chalirmpoj Pimpisarn, ©iStock.com/Jirsak