Inheritance tax and term life insurance: what about it?
Everyone who receives an inheritance pays a portion of tax on it to the government. What many people don't know is that the receipts from a life insurance policy are also subject to this tax. Indeed, in certain cases, the Internal Revenue Service considers this income as a type of inheritance.
What exactly is the situation with term life insurance and inheritance tax? Does that tax always apply or are there exceptions? Read everything you need to know here.
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How does inheritance tax work with term life insurance?
If you receive an inheritance, in most situations you will also pay taxes on that amount of money. This is also the case with term life insurance if the insured, meaning the person who died, was also responsible for paying the premium of the term life insurance.
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Inheritance tax & term life insurance
This is always a situation in which the deceased policyholder paid the monthly premium himself from his own assets. Whether inheritance tax is effectively payable in that case depends on:
- The size of the share of the inheritance received by the survivor
- The relationship between the survivor and the deceased policyholder
In doing so, it is important to note that exceptions are possible. Any amount that falls under these exemptions is exempt from inheritance tax.
Here's how to avoid inheritance tax with term life insurance
If the insured himself paid the premium or a piece of it out of his or her own assets, then the person receiving the benefit is responsible for paying the inheritance tax. However, this is true only if the entire inheritance exceeds the exemption.
In certain cases, it is possible to avoid inheritance tax with term life insurance. What is important here is that the person who receives the money pays for the insurance and that this is stated in the policy. In that case, paying the inheritance tax is not mandatory.
Important: In the latter case, it is not possible to pay for the death insurance with shared assets. If you are married or in a registered partnership with community of property, the inheritance tax cannot always be avoided!
Situations in which you can avoid inheritance tax
As mentioned, there are certain situations in which you don't have to pay inheritance tax on the death insurance payout. Here's some more info:
As a partner or spouse
Is there a marriage or registered partnership with community of property? Then the inheritance tax is mandatory since the assets are shared.
This is because the Internal Revenue Service assumes that the deceased policyholder paid a portion of the premium for the term life insurance policy. A portion of the benefit is therefore subject to inheritance tax, which must be paid by the recipient. This is only the case if the complete inheritance and the benefit combined exceed the exemption for that tax.
As a spouse or registered partner
If there are prenuptial or partnership agreements between two partners, the assets are separated. This means that you can indeed avoid inheritance tax, at least if the conditions clearly state which assets are used to pay the premium for term life insurance. It is definitely worth seeking advice on this from an expert or notary.
Is the information related to paying the insurance premium clearly stated in the terms and conditions? If so, there are two possible routes:
- Your partner takes out life insurance on your life
In this case, one of the partners is the so-called beneficiary and thus pays the premium. The other partner is the insured and this is also stated in the terms and conditions. If both partners want to be insured, this is also possible. In that case, there are two separate insurance policies, which is also called cross-insurance.
- splitting of premiums
Two partners may also prefer to take out one policy with two insureds. In that case, splitting the premium is a good idea. In this case, the policy terms will state what portion of the premium is for one life insurance policy and what portion is for the other.
For someone else
Finally, it is also possible to avoid inheritance tax if it involves a friend, children or a business relationship about which nothing was recorded on paper.
In that case, it is important not to pay the premium with your own assets. Instead, have that done by the person receiving the benefit. Then your child, partner or business associate is payer of the premium and policyholder!