Is Life Insurance Tax Deductible?

Life insurance can be an important part of your financial planning—and when it comes to financial planning, 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?

If you’re searching for a quick answer to this question, we’ll save you some time. Usually life insurance premiums aren’t tax deductible, but there are some exceptions (more on that in a moment). From the perspective of the IRS, paying for your life insurance premiums is like buying a car or paying for cell service—there’s no income tax deduction.

Here’s a quick summary of the more common exceptions to the general rule that life insurance premiums aren’t tax deductible.

• 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.

If you’re retiring, you may wonder if you’ll get better tax treatment on your premium dollars, but retirement doesn’t make a difference.

Below, we’ll share some details about the exceptions.

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. In three different situations, businesses can receive tax benefits for the group term life insurance premiums they paid. (Group term life is offered to a group, such as an organization’s employees. They get coverage under a single policy for a certain term, which often ends 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, and 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 is not applicable to shareholders of 2 percent or greater of an S corporation.
3. Life insurance premiums paid for shareholders who have 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

In a divorce or separation, the agreement sometimes specifies that life insurance must be provided. If a divorce or separation agreement was finalized before 2019 and requires one spouse to pay life insurance premiums on his or her life for the benefit of the other spouse, then it may be deductible as alimony if the other spouse (payee) owns the policy. Consult your tax advisor if you think this exception applies to you.

Some policies donated to charity may be tax deductible

There’s another exception that could work if your loved ones won’t need your permanent life insurance death benefit. Donating your policy to charity is an option, and there are many ways to do this. If a charity becomes the owner and beneficiary of your life insurance policy, you may be able to deduct the value of the policy on your personal income tax return. The rules are complex and specific, so work with your tax advisor if you want to donate your policy to charity.

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 since your estate may need the funds to pay taxes or your final expenses. And keep in mind that, once the policy is gifted to charity, you won’t be able to access the funds that may be available in that policy during your lifetime.

More tips about taxes and life insurance

Although premiums typically aren’t tax deductible, life insurance is a tool that can help you manage the impact of taxes. While the details can sometimes be a little complicated, your financial advisor and tax professional can help you understand how everything works to help you get the best outcome for your situation. Life insurance is a common tool for people whose estate will probably be subject to estate tax or for people who think their estates or loved ones will need cash to manage final expenses.

Permanent life insurance cash value may be tax deferred

Permanent life insurance policies feature a cash accumulation component in addition to coverage for your entire life. Cash value in certain types of permanent life insurance policies will grow over time, and taxes on the growth are deferred.

Once you accumulate cash value, you can use it for anything you want. That might be collateral on a loan, helping pay for college, a downpayment on a house or even your premium payments.¹ Whole life, variable life² and universal life (including variable universal life²) are some of the most common types of cash value life insurance policies.

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 received from a life insurance policy 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. That payout usually won’t be considered income, and your family can be protected from financial hardship. (But if your family chooses to spread the payments over time and the insurance company adds interest, those interest payments will be taxable.)

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 in the “estate tax,” and some states also have an “inheritance tax.” These are the taxes charged when someone’s property, possessions and financial holdings transferred upon their death exceed a certain limit. 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.

If you’re considering life insurance, your Northwestern Mutual financial advisor can talk you through the pros and cons of our solutions and how they fit into your overall plan. They can also review your financial plan to look for opportunities and blind spots that you might overlook. Your Northwestern Mutual financial advisor can help figure out what’s right for you.

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.