Life insurance death benefits aren’t typically taxed, which is one of the primary upsides to life insurance. Since life insurance death benefits can be in the millions of dollars, it’s a significant advantage to buying (and receiving) life insurance.

But there are other aspects to life insurance that won’t get past the taxman.

Is a Life Insurance Payout Taxable?

Life insurance death benefit payouts are usually not taxable. That means beneficiaries will receive the money without a tax burden hanging over their heads.

However, there are certain situations where a life insurance death benefit may be taxable. Here’s a look at when to prepare for a tax bill.

You are a life insurance beneficiary who receives interest on a death benefit

Most life insurance payouts are made in one lump sum right after the death of the insured person. But if a beneficiary chooses to delay the payout or take the payout in installments, interest may accrue. In that case, the interest paid to the beneficiary may be taxed.

The life insurance payout goes into a taxable estate

Most life insurance payouts are made tax-free directly to life insurance beneficiaries. But if a beneficiary was not named, or is already deceased, where does the life insurance death benefit go? It goes into the estate of the insured person and can be taxable along with the rest of the estate.

This could create a significant tax bill, especially considering both federal and state estate taxes may be applied. While federal estate taxes will not tax the first $12.06 million per individual as of 2022, state estate taxes can have significantly lower exemption levels.

Another possible unhappy scenario is that an estate is below the exemption level but a large life insurance payout to the estate pushes it above the exemption threshold into taxable territory.

This is avoidable by naming both primary and contingent life insurance beneficiaries and keeping those selections up to date.

The life insurance policy involves three different people

Life insurance death benefits can become a taxable gift in a situation where three people serve three different roles in connection with the life insurance policy. The positions include:

• The policyowner. This is the person who purchased the policy and is ultimately responsible for paying the premiums.
• The insured. This person’s life is covered by the life insurance policy.
• The beneficiary. This person receives the death benefit when the insured person dies.

For example, say a husband purchases a life insurance policy for his wife, and their son will be paid the death benefit. Suppose the wife (the insured) dies and the son (the beneficiary) receives the death benefit. In that case, the IRS considers the life insurance payout a gift from the husband (the policyowner) to the son. This is sometimes referred to as the “Goodman triangle” or “Goodman rule,” named after a decades-old court case regarding this issue (Goodman v. Commissioner of the IRS).

If this triangle exists, the policyowner may have to pay gift tax for the life insurance payout that exceeds federal gift tax exemption limits. In 2022, the annual gift exclusion is $16,000 per individual and the lifetime limit (known as a basic exclusion) is $12.06 million per individual.

To avoid tax implications from the Goodman triangle, limit insurance policy involvement to only two people: a policyholder who is also the insured and the beneficiary. A remedy to the example above is for the wife to be the policyowner and insured, maintaining the son as the beneficiary.

Is the Cash Value in a Life Insurance Policy Taxable?

If you have a cash value life insurance policy, you can generally access the money through a withdrawal, a loan or by surrendering the policy and ending it.

One of the reasons to buy cash value life insurance is to have access to the money that builds up within the policy. When you pay premiums, the payments generally go to three places: cash value, the cost to insure you and policy fees and charges. Money within the cash value account grows tax-free, based on the interest or investment gains it earns (depending on the policy). But once you withdraw the money, you could face a tax bill.

Money that’s withdrawn from cash value is generally made up of two parts:

If your life insurance policy is a “modified endowment contract,” or MEC, different tax rules apply and it’s best to consult a financial professional to understand tax implications.

Here are situations where cash value may be taxable.

You surrender the life insurance policy

There can be times when a policyowner no longer wants or needs the life insurance policy. You can take the surrender value of the life insurance policy and the insurer will terminate the coverage. The amount you receive is your cash value minus any surrender charge. You can generally expect to get a surrender charge within the first 10 or 20 years of owning the policy, and over time the surrender charge phases out.

You won’t be taxed on the entire surrender value, though. You’ll be taxed on the amount you received minus the policy basis, or the total premium payment you made on the policy. This taxable amount reflects the investment gains that you took out.

Say the premiums you’ve paid over many years add up to $38,000 and your total cash value is $45,000. The portion of the payout that would be taxed is $7,000, representing the investment gains.

You took out a policy loan and the life insurance ends

If you have a life insurance policy with cash value and take out a loan against it, the loan isn’t taxable—as long as the policy is in force. But if the policy terminates before you’ve paid the loan back, you could get a tax bill. For example, the coverage terminates if you surrender the policy or it lapses.

The taxable amount is based on the amount of the loan that exceeds your policy basis. Policy basis is the portion you’ve paid in premiums. Amounts “above basis” are based on interest or investment gains on cash value.

One way to access all your cash value and avoid taxes is to withdraw the amount that’s your policy basis—this is not taxable. Then access the rest of the cash value with a loan—also not taxable.

If you die with a loan against the policy, the death benefit is reduced by the outstanding loan amount.

You sell the life insurance policy

There’s a market for existing life insurance policies, especially cash value life insurance policies that insure people who are terminally ill or have short life expectancies. Transactions involving terminally ill policyowners are called “viatical settlements.” These involve an investor, such as a company specializing in buying policies, paying you money for the policy, becoming the policyowner and then making the life insurance claim when you pass away.

Viatical settlements are typically used as a way for patients to get money for medical bills, especially when selling a life insurance policy will mean getting more money than simply surrendering it for the cash value.

Fortunately, the IRS doesn’t treat any portion of what you receive for a viatical settlement as taxable. Under IRS code 101(g)(2), an amount paid by a viatical settlement provider is treated like a payment of the death benefit—and death benefit payouts are not taxable.

A life settlement is a similar transaction but involves a policyowner who is not terminally ill. In these cases, the IRS does not see the proceeds as a payment of death benefit. A portion of what you receive can be taxable.

Summary: When Is Life Insurance Taxable?

More than half of Americans have life insurance. And the primary advantage of having life insurance is that you can provide a death benefit to anyone you name as a beneficiary.

What Is a Life Insurance Death Benefit?

A death benefit is the amount your life insurance policy will pay to your beneficiaries if you pass away, as long as your policy is in force.

Who Gets the Death Benefit?

Life insurance beneficiaries are the people or organizations you’ve chosen to receive the death benefit from your life insurance policy.

A beneficiary could be:

• People, such as a spouse or your adult children
• Charities
• A trust
• A business

You can choose multiple beneficiaries for your life insurance policy and you can select how much of the death benefit goes to each. For instance, a business, an individual and a charity could all be named as beneficiaries on the same policy.

You can designate the percent of death benefit to each beneficiary, such as 80% to a spouse and 20% to a brother.

A policyholder can remove or add beneficiaries at any time.

How beneficiaries can use a death benefit

Beneficiaries can use money from death benefits however they choose. Beneficiaries often use this money for everyday bills like groceries and utilities, for larger debts like a mortgage or to put a child through college.

How Do Life Insurance Death Benefits Work?

A death benefit is typically paid in a lump sum to beneficiaries, but there are other options.

Death benefit payout options

There are several ways to receive a life insurance payout. Here are the usual death benefit payout options.

• Lump-sum payout: This type of death benefit is paid out all at once, rather than over a period of time. It is generally not counted as taxable income.
• Retained asset account: Beneficiaries might have the option to leave the death benefit with the insurance company in an interest-bearing account. You typically get a checkbook to access the cash in the account. Any interest earned will be taxable.
• Life income payout: You may be able to receive the death benefit in guaranteed payments for the rest of your life. The amount you receive in each payment will be based on your age when you file the life insurance claim.
• Life income with period certain: This option allows you to receive payments for a certain period, and for your beneficiaries to receive the remaining payments if you die before the period is up.
• Specific income payout: This type of death benefit is paid out in installments over time, such as 10% annually for 10 years. The portion of the benefit that has not been paid out generally earns interest for the beneficiary. Any interest earned over this period will be taxable.

Death benefits with different types of life insurance

Here is how the death benefit works with term life vs. permanent life insurance.

• Term life insurance: Term life insurance policies lock in level premiums for a set period, such as 10, 20 or 30 years. If you pass away while your term life policy is in force, your beneficiaries receive the payout. No death benefit will be paid if your policy expires and you’re still living.
• Permanent life insurance: Permanent life insurance is designed to stay in force for your entire life. If you pass away at any time, your beneficiaries will receive a death benefit—as long as your policy has not lapsed due to lack of payment.

There are certain circumstances in which a death benefit may be lower than the policy’s face value. For example, if you have life insurance with a cash value account and take out a loan without paying it back, this amount will be subtracted from the death benefit if you pass away.

Cash value accounts are savings or investment accounts that come with certain types of whole life insurance and accumulate value. Typically, if you don’t use the money in your cash value account before you pass away, the cash value reverts back to the life insurance company if you pass away.

How Much Is My Death Benefit?

The death benefit amount is based on the face value of the life insurance policy, with subtractions for any withdrawals you made from cash value or policy loans you didn’t pay back.

For example, you bought a $500,000 term life insurance policy, the payout to your beneficiaries will be $500,000. (Term life insurance does not have any cash value for policy loans or withdrawals.)

When deciding how much money you should provide to your beneficiaries, consider your reasons for buying life insurance. If you want to provide funds to replace your income for 10 years, you could choose a death benefit that closely matches your income multiplied by 10.

How Do Death Benefits Affect My Premium?

The size of your death benefit is one factor that affects how much you’ll pay in life insurance premiums. Other factors include the type of life insurance, your age, gender, health and whether you use nicotine.

The following examples show examples of premium payments for certain death benefit amounts.

Average annual costs for a variety of term life insurance amounts

Note that these examples are meant to be used for comparison. The most accurate way to see how much you’d pay for a certain policy is to compare life insurance quotes.

Types of Death Benefits

There are a few types of death benefits to consider when buying life insurance.

Fixed death benefit

This common type of death benefit is a set, unchangeable amount. For example, whole life insurance policies have fixed death benefits.

Some term life insurance policies have fixed death benefits, too, but other term life policies allow you to adjust a death benefit, such as lowering the amount.

Adjustable death benefit

Some universal life insurance policies allow you to adjust the death benefits amount (within certain parameters). You can choose a higher or lower death benefit over the course of the policy’s life. Doing so will change your premium payments.

Graded death benefit

With a graded death benefit, your beneficiaries won’t get paid the full death benefit if you die from a health condition within the first few years after buying the policy. Life insurance policies that don’t require a medical exam or ask a lot of health questions, such as guaranteed issue life insurance, commonly have graded death benefits.

How to File a Claim and Receive a Life Insurance Death Benefit

1. Call the life insurance company. The key to making a claim is to know which life insurance company holds the policy for the deceased person. You don’t need the policy number to make a claim. When you report the death to the life insurance company, the insurer can verify that you are a beneficiary on the policy.
2. File a claim and send a certified death certificate. Expect to be required to send a certified copy of the death certificate along with claim paperwork. You can typically get a copy of this document from the funeral home or medical professional who confirmed the death of the individual, or from a vital records office.
3. Fill out the insurance company’s required paperwork. The life insurance company can send you a claims form or direct you to it online.
4. Wait for the claim to be processed and paid out. There is typically no time limit for submitting a life insurance claim, but the sooner you file the claim, the sooner you will receive the death benefit.

Could a Life Insurance Claim be Denied?

There are situations where a life insurance claim could be denied, such as:

• You aren’t a beneficiary. In some cases a life insurance policyholder will change beneficiaries without informing the previous beneficiaries.
• The life insurance policy had lapsed due to lack of payment. If someone forgets or neglects to pay the premium, there’s typically a grace period. After that, the policy will lapse. If the insured person passes away while coverage is not in force, there is no death benefit payment. If the policy lapse was very recent—for example, because the policyholder was in the hospital and didn’t pay their bills—it may be possible for the beneficiary to pay the premiums due and then receive the death benefit.
• Fraud was involved. If an applicant purposely hides a medical condition or other relevant information from their life insurance company, their beneficiaries might not receive the death benefit. Most life insurance policies have a two-year contestability period during which a claim might not be paid on a death if there was fraud or misrepresentation on the life insurance application.
• The insured died from suicide. Life insurance policies generally do not pay out death benefits if a person passes away from suicide within the first two years after purchasing a life insurance policy.

When purchasing life insurance, you might consider a 20-year term life insurance policy if you want affordable coverage that locks in your rate for the next two decades, even if your health changes.

What Is 20-Year Term Life Insurance?

A 20-year term life insurance policy guarantees that you lock in a rate for 20 years. You pay a level premium, and if you pass away while your coverage is in force, your beneficiaries receive a death benefit.

There’s no cash value component with term life insurance as there is with types of permanent life insurance. However, term life is generally the cheapest type of life insurance to buy.

How Does a 20-Year Term Life Insurance Policy Work?

When you buy a 20-year life insurance policy, you will select a:

• Coverage amount, also known as the death benefit.
• Beneficiary, or beneficiaries, who will receive the death benefit.

Your beneficiaries can use the death benefit to cover any expenses if you die, including funeral and burial costs, education expenses, everyday bills or outstanding debts, like a car loan or mortgage.

The amount of coverage you buy will depend on your financial goals. For example:

• If your goal is to pay off your house, you might purchase enough coverage to cover the remaining balance of your mortgage if you pass away.
• If your goal is to provide income replacement to help your loved ones manage household expenses, you might choose a death benefit that equals 10 years of your income.

What happens after 20 years?

At the end of the 20-year life insurance term, the period for fixed premiums expires. If you decide not to renew the policy—or renewal is not available for the policy—no death benefit will be paid to your beneficiaries.

Can a term life policy be extended?

A 20-year term life insurance policy can typically be extended past the initial term, but doing so will increase your premiums significantly, and the rate will continue to rise each year. Renewal after the level-term period is usually not a good option because of the expense.

You may also have the option to convert the term life to permanent life insurance, which typically lasts a lifetime and can build cash value. But if you don’t need permanent life insurance, buying a new term life insurance policy would be more affordable.

All of these options will increase your premiums after the 20-year level term, so the smart choice is to buy term life insurance for the number of years you will need it. If you expect to need life insurance for more than 20 years, consider buying a 30-year term life insurance policy.

Who Is 20-Year Term Life Insurance For?

Here are some factors to weigh when deciding if 20-year term life insurance is a good fit for your situation.

Age

Your age impacts how much you will pay for term life insurance coverage. Life insurance quotes get more expensive as you get older, and even more so if your health declines.

It’s best to lock in a rate for the number of years you will need life insurance. This will help you avoid needing to buy a new term life policy down the line, with higher premiums for the same death benefit.

However, if you are nearing retirement age and only want life insurance to cover your remaining working years, a 10-year term life insurance policy may suffice. Because of its shorter term, your premiums would be more affordable.

Financial responsibilities

Taking stock of your financial responsibilities will help you to determine whether a 20-year life insurance policy is a good fit. You might consider this type of life insurance if over the next 20 years you’d want the death benefit to help your beneficiaries with:

• Making car payments
• Paying a mortgage
• Paying credit card bills
• Planning for retirement
• Providing for a spouse and/or children
• Repaying student loans
• Saving for education expenses

Life changes

Major life changes, such as having a baby, could necessitate purchasing 20-year term life insurance. If you want to make sure your child’s college education is paid for, for instance, you might want a 20-year policy in place to cover tuition if you were to pass away.

How Much Does a 20-Year Term Life Insurance Policy Cost?

The average cost of a 20-year term life insurance policy is $252 a year for $500,000 in coverage for a 30-year-old female, based on Forbes Advisor’s analysis of life insurance rates.

The amount you’ll pay for life insurance will usually depend on several factors, including your age, gender, health and smoking status. Occupation and hobbies can also factor in. Here are the average life insurance rates for a 20-year term life insurance policy for different ages and genders.

Is a 20-Year Term Life Policy Worth It?

A 20-year term life insurance policy could be worth it if you’re looking for a simple, affordable life insurance policy that guarantees fixed premiums for 20 years and a guaranteed death benefit if you die while the policy is in force.

Remember to consider what happens at the end of the 20 years. If you think you will still need coverage after 20 years, it would be better to lock in rates for a 30-year term life insurance policy or possibly even buy permanent life insurance, which is designed to last a lifetime.