Advanced Underwriting Consultants

Ask the Experts – January 8

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers.  Here’s the question of the day.

Question: If the beneficiary of a life insurance policy has the option to receive the death benefits in installments throughout her life, will she still receive the payments tax-free?

Answer: Not entirely. While life insurance proceeds are generally excluded from gross income, if they are received as installments throughout the life of the beneficiary, the interest portion of each payment will be taxable as ordinary income.

To determine the excluded part, divide the total amount held by the insurance company (usually the lump sum payable at death) by the number of installments to be paid.

If the payments are to continue throughout the life of the beneficiary, divide the amount held by the insurance company by the beneficiary’s life expectancy. The amount held by the insurance company is reduced by the actuarial value of any refund or guarantees.

For example, consider a taxpayer who chooses to receive $825 every month for the remainder of her life as opposed to a lump sum of $90,000. If she is expected to live another 10 years, she may exclude $750 ($90,000 ¸ 120 months) from her gross income, resulting in $75 of ordinary income in the first month.

As you might notice, receiving the life insurance proceeds through periodic installments for life reaches the same tax results as accepting a lump sum payment and then purchasing an immediate annuity for life.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.