Life Insurance Taxation
Course: Insurance Planning
Lesson 12: Types of Life Insurance
Student Question:
Am I correct in thinking that, as a rule, if a life insurance policy is paid for with after-tax dollars (non-deductible) that death benefit proceeds are always received tax free?
Instructor Response:
You are directionally correct but let’s dig a little deeper.
Generally, death benefits from a life insurance policy are received income-tax free to the beneficiary whether the premiums are paid with pre-tax or after-tax dollars. This is true for group life insurance policies and life insurance coverage provided through an employer-sponsored (qualified) retirement plan.
As an exception, DBO plans are part of a broad group of employee benefits referred to as non-qualified deferred compensation. As such, the DBO plan is a contract between employer and employee that commits the employer to pay death benefits to the employee’s beneficiaries at the employee’s death. Key point—the employee may defer compensation into the DBO plan. The employer may use that deferred compensation to purchase life insurance on the employee. The employer generally owns the policy.
The payment of the death benefit to the employee’s beneficiary is considered the payment of deferred compensation. Deferred compensation in the form of a death benefit is taxable to the beneficiary when received. DBO plans can be designed in a number of ways and our online content and this email describe one of, if not the most, common design.
