Advanced Underwriting Consultants

Question of the Day – December 5

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: My client wants to lock in an income settlement option for the beneficiary of her life insurance policy.  Is that possible?  How would the payments under the settlement option be taxed?

Answer: Whether or not the policy owner may lock in certain settlement options for a life insurance beneficiary is a question of life contract language and company practice.  Some carriers and contracts will permit such a choice, others will not.

A lump sum death benefit under a life insurance contract is generally income tax free.  If the beneficiary receives an annuity income stream instead, the annuity payments are taxable under normal immediate annuity rules.  The contract’s death benefit amount would be the basis, and any excess amounts paid in a year would be taxable income.

Here’s an example.  Say that Martha is the owner and insured under a $500,000 life insurance contract, and she names Fred as the beneficiary.  Martha decides to lock Fred into a ten year certain immediate annuity payout at Martha’s death.

Assume that Martha dies, and the company calculates the ten year certain payout to Fred to be $60,000 per year.  Fred would recover the basis under the annuity contract—the $500,000 death benefit—in equal proportions over the ten year period.  Therefore, $50,000 of the payment would be a tax free return of basis, and the other $10,000 would be considered taxable interest.

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.