Life insurance proceeds paid to you because of the death of the insured generally aren’t subject to federal income tax unless the policy was transferred to you for valuable consideration. This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract. However, any interest earned on life insurance proceeds after the insured’s death, including interest earned while the proceeds remain on deposit with the insurance company, is generally taxable and must be reported as income.

NOTE Although life insurance death benefits generally aren’t subject to federal income tax, state tax treatment may differ. In some situations, state estate, inheritance, or other taxes may apply.

See IRS Publication 525 Taxable and Nontaxable Income for more information.

Proceeds not Received in Installments

If death benefits are paid to you in a lump sum or other than at regular intervals, include in income only the portion of the payments that exceeds the amount payable at the insured person’s death. The excess generally represents taxable interest earned after death.

If the benefit payable at death isn’t specified, you include in your income the benefit payments that are more than the present value of the payments at the time of death.

Proceeds Received in Installments

If you receive life insurance proceeds in installments, you can exclude part of each installment from your income.

To determine the excluded part, divide the amount held by the insurance company (generally, the total lump sum payable at the death of the insured person) by the number of installments to be paid. Any amount received above the excluded portion of each installment is generally taxable as interest income

Example 25. The face amount of the policy is $75,000 and, as beneficiary, you choose to receive 120 monthly installments of $1,000 each. The excluded part of each installment is $625 ($75,000 ÷ 120), or $7,500 for an entire year. The rest of each payment, $375 per month (or $4,500 for an entire year), is interest income to you.

Installments For Life

If you are entitled to receive life insurance proceeds in payments for the rest of your life and there is no refund or guaranteed minimum payment period, the nontaxable portion of each payment is generally determined by dividing the amount held by the insurance company by your life expectancy. Any amount received above the nontaxable portion is generally taxable. If the payment option includes a refund feature or a guaranteed payment period, special rules apply and the amount used in the calculation is reduced by the actuarial value of that guarantee.

Surrender of policy for cash

If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. In most cases, your cost (or investment in the contract) is the total of premiums that you paid for the life insurance policy, less any refunded premiums, rebates, dividends, or unrepaid loans that weren’t included in your income.

You should receive a Form 1099-R showing the total proceeds and the taxable part. Report these amounts on lines 5a and 5b of Form 1040 or 1040-SR. See Form 1099-R – Entering Distributions from Retirement Plans.

Note that any link in the information above is updated each year automatically and will take you to the most recent version of the webpage or document at the time it is accessed.