A common question I receive from my clients concerns the delicate relationship between their insurance premiums and taxation: is there any way they can pay less on insurance? Are insurance premiums tax-deductible in 2022? Are there any loopholes they should be using that they don’t know about? According to a study conducted by Value Penguin, almost half of Americans believe that insurance premiums are tax-deductible. While that may be the case for specific circumstances surrounding home and auto insurance, things look a bit different when it comes to life coverage.
Life Insurance and Taxation
First things first – let’s quickly go over what life insurance is all about. As I mentioned in one of our previous articles, life insurance is basically a contract between you and your insurance carrier stating that a designated beneficiary will be awarded a lump sum of money in the event of your death. If your policy is temporary (as opposed to permanent), you would need to pass away in a specific time frame in order for your loved ones to receive the benefit. If you opted for a permanent policy – such as whole life or universal life insurance – the death benefit will be paired with a savings account funded by your premiums, which accumulates interest over time.
We can therefore conclude that life insurance is a discretionary financial safety net that can help people feel at ease in the most difficult of times. So, would it make sense for it to be tax-deductible?
Is Life Insurance Tax Deductible in 2022?
The short answer – no. Seeing how the state isn’t mandating life insurance in any way, the IRS considers your policy a personal expense. Thus, no reason to exempt it from taxation. That being said, there are three exceptions to this rule.
You’re an Employer Paying for Your Employee’s Life Insurance Policy
The first exemption concerns business expenses. If you’re an employer who decides to supplement your employee benefits package with a group life insurance policy, you can deduct the money you spend on premiums from taxation. But there’s a catch – the tax-exempted coverage can’t exceed $50,000. For example, if you acquired a $75,000 insurance policy for your CTO with a monthly premium of $75, you’ll pay taxes on the $25 that finance the extra $25,000 coverage. Note that in order for this to apply, you can neither directly nor indirectly be the beneficiary of your employee’s policy.
You Have an Alimony Agreement that Dates Before 2019
If in your divorce proceedings you were mandated by the court to purchase a life insurance policy as part of the alimony agreement, you can safely deduct your premiums provided they don’t correspond to a pre-existing insurance policy that lists your former spouse as a beneficiary. This is only available for older alimony agreements (pre-2019), as tax code provisions regarding such settlements have changed in recent years.
You Donate Your Life Insurance Policy
If you decide to name a charitable organization as the beneficiary of your life insurance policy or to hand your policy over to them altogether, you can deduct the amount of money you paid on premiums from your tax returns. If your insurance accumulated a cash value that exceeds what you paid on premiums, you can deduct whichever sum is smaller.
Should You Pay Taxes on Your Life Insurance Policy?
In terms of paying taxes on your life insurance policy, things become slightly nuanced. Term life insurance is pretty straightforward – your beneficiaries won’t have to pay any taxes on the death benefit, seeing how there’s no cash value component to the policy. Permanent life insurance, however, is different.
Whole life and Universal life insurance policies accumulate cash value over time. In turn, the cash value accumulates interest. For this reason, some policies become investment vehicles that generate income for their owners, and income taxation laws start to apply. Keep in mind a couple of things:
- The savings are tax-deferred. This means that you don’t have to pay a dime in taxes until you cash out the policy. Seeing how you can end up paying your premiums using the policy’s cash value without having to make any withdrawals, this can be quite advantageous.
- If, at any point, you decide to withdraw the policy’s cash value, you’ll pay taxes only on the difference between the money you receive and the premiums you paid to enforce your coverage.
The Bottom Line
As a rule of thumb, life insurance premiums are not tax-deductible and exceptions to this rule are scarce. However, there are other scenarios where you can safely exempt your insurance premiums from taxation. For example, have you been working from home in 2022? If the answer is “yes”, you’re in for a happy surprise. Head to our blog to find out more.
And if you have other questions or need assistance with your life insurance policy, please drop me a line – I’d love to help you figure things out.