Are life insurance premiums tax deductible?

Life insurance policies ask for a premium in return for offering coverage. Typically, the amount you'll pay for your premium each month is a key factor in choosing a new policy. And those premiums may bring added tax benefits.

But are life insurance premiums tax deductible? Here's how to navigate the possible tax implications of your policy.

A tax deduction reduces your taxable income. Many cases call for a standard deduction—however, if itemizing your deductions exceeds the standard deduction, you'd likely want to use that itemized deduction instead. As an example, you may be able to claim an itemized deduction on certain donations to qualifying charitable organizations via form 1040, Schedule A.

Generally, life insurance premiums are not tax deductible. However, there are some exceptions to this rule. For instance, some businesses may deduct premiums they pay on behalf of employees.

Life insurance premiums may be tax deductible in some cases, including:

• Group term life insurance. The IRS allows for an exclusion of the first $50,000 of group term life coverage offered by some small business owners. The total benefit of the policy cannot exceed $50,000; above that amount, the cost of coverage must be included in income and is subject to Social Security and Medicare taxes. In these cases, the small business can deduct the premiums paid on behalf of employees from their taxes.

• Giving life insurance to charity. Transferring ownership of your life insurance policy to a charitable organization can provide a tax benefit. When you gift your policy to a qualifying charity, both the premiums you paid into the policy as well as premiums paid after the transfer may be tax deductible. Note: The amount of the premiums that may be deductible after gifting the policy to the charity may vary if the premium is paid directly to the insurance company instead of to the charity.

• 162 Executive Bonus Plans. Business owners can deduct premiums for individual life insurance coverage on a key employee, if that executive reports the premium payment as taxable income.

• Older alimony agreements. Spouses required to buy life insurance as part of an alimony agreement made prior to 2019 may qualify for a tax deduction on their premiums. However, due to tax code changes resulting from The Tax Cuts and Jobs Act, tax deductions for alimony payments are no longer allowed for life insurance premiums as of 2019 and later.

Generally speaking, life insurance death proceeds are income tax-free. If the policy owner dies while the policy is still active, beneficiaries may receive an income tax-free payout to use however they choose. With that said, there are some important things to note:

• Death benefits paid by installments. If a beneficiary chooses to receive the death benefits in installments, he or she may generate some taxable income. But only on amounts that exceed the death proceeds, which is determined by the settlement option the beneficiary selects.

• Estate taxes. The IRS allows a lifetime tax exemption on gifts and estates. Each year, this limit adjusts for inflation. The estate tax exemption is $13.61 million for 2024. Because life insurance proceeds are considered part of a beneficiary's taxable estate, those proceeds could be subject to estate tax if the amount exceeds their remaining lifetime exclusion at the time of the policy owner's death. Though this differs from income tax, it's still worth consideration.

• Transfer-for-value rule. Some insurance companies may allow you to sell your life insurance policy to someone else in exchange for something of value (i.e., money, a property or other valuable item). In those cases, part of your death benefit would then be taxed as ordinary income assuming it does not fall under an exception.

The cash value of permanent life insurance is not taxed while it remains within the policy as a cash value component. In other words, as long as your cash value is growing in the policy, the growth is tax-deferred. However, if you surrender your policy or decide to make withdrawals from your cash value, you'll owe taxes on the interest earned. Partial surrenders generally will be treated as a non-taxable recovery of premium and then as income received from the policy. Because of this, a partial surrender from a policy will typically not count as income, unless it exceeds the investment in the policy immediately before the partial surrender. That's assuming your policy is not considered a Modified Endowment Contract, or MEC.

In the case of a MEC, tax implications change. Distributions including loans and partial surrenders from the policy will be treated as withdrawals of income first and then as a recovery of investment in the policy. Distributions including loans and partial surrenders made before age 59 1/2 also may be subject to a 10% penalty on the portion of the proceeds that is includible in the income. But similar to non-MEC insurance policies, MEC death benefits remain income tax-free. If you're concerned about your policy becoming a MEC, you can ask your insurance company about the limits on premiums that can be added each year.

As a non-MEC example, say you own a whole life policy with $20,000 in cash value. You then decide to withdraw the cash value or surrender the policy. If you've paid $15,000 in premiums, and $5,000 represented the interest, you'd pay tax on the $5,000 in interest—but not the other $15,000 in premiums.

Shopping for the right insurance policy involves much more than searching for the lowest premium, and it's smart to ask many questions about how taxation can affect policies before choosing one. Are life insurance premiums deductible? Does cash value grow tax deferred? Are your policy's distributions taxable? As you navigate the specific rules and exceptions surrounding life insurance taxation, a financial advisor can help.

Together, you can explore life insurance premiums, tax implications and more.