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Nothing is more frustrating to find out that you have paid for something over a long period of time, and find out that in the end you received less than what you expected. This is can be true with life insurance if you don’t know the taxation rules set forth by the IRS on death benefits.

According to the Internal Revenue Code, the IRS can tax benefits from a life insurance policy provided by an employer to an employee if the benefits are greater than $50,000 and if the employer provides any or all of the payments for coverage. The IRS classifies such life insurance as being “carried by the employer” and therefore the payout at death over $50,000 can be taxable.

This means that if your life insurance through work is greater than $50,000 and your employer is paying any or all of the premiums on this policy your beneficiaries will be forced to pay taxes on everything over the $50,000 maximum.

Lets say for example you work for a company that supplies a benefit to its employees of “one times annual salary” in life insurance free of charge and then allows the employee to purchase additional amounts of life insurance at a reduced group rate. This means that if you make $35,000 a year the company will pay for a life insurance policy for you up to $35,000 and allow you to buy an additional amount of insurance under their group plan.

If you choose to exercise the option for the company to purchase your life insurance for you, you will be alright if your family ever has to make a life insurance claim because your salary ($35,000) is less than the $50,000 maximum that the IRS has set. However if you purchase, lets say, $200,000 in life insurance, paying the difference between what the company provides free of charge, then the IRS will tax $150,000 of the benefit that your family will receive at the point of your untimely demise.

Taxes on life insurance are figured differently than regular income, and if this situation arises you should seek out the help of a CPA or Tax Attorney. The best way to avoid paying a tax to start with is to know the rules. Allow your company only to pay for up to the $50,000 maximum if you can, and take out a life insurance plan of your own outside of work to cover your other needs. Another way of dealing with this is to talk with a CPA find out how much tax will be required at death and purchase a small life insurance plan outside of work to pay for the tax when the time comes.

Links:

http://www.irs.gov/govt/fslg/article/0,,id=110345,00.html

http://www.irs.gov/pub/irs-pdf/p15b.pdf

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