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Are Proceeds from a Life Insurance Policy Taxable?

MP900382633There’s some confusion over when people must pay taxes on insurance policy proceeds and when they do not. Here’s a look at how it works, in different scenarios.

Here’s a scenario to start with: a couple both have life insurance policies on each other for $500,000, and they have no children. They have named each other as the primary beneficiary, and the contingent beneficiaries are a sister and a nephew. If circumstances occur so that the sister and the nephew are the recipients of the proceeds, do they have to pay an inheritance tax? asked and answered this question in its recent article, “Do the beneficiaries of life insurance have to pay inheritance tax?” Although New Jersey’s state estate tax is gone, there’s still an inheritance tax.

Life insurance—when paid to a named beneficiary or a trust for the benefit of a named beneficiary—is a specific asset that’s exempt from New Jersey’s inheritance tax, despite the relationship of the beneficiary to the decedent.

If the life insurance was left to the owner’s estate, and the estate was passed to the brother and niece under the will, it wouldn’t be exempt from the inheritance tax. It wouldn’t matter that the brother and niece were named as contingent beneficiaries on the life insurance policies, so long as they were named as beneficiaries on the policy and wouldn’t be taking the proceeds as beneficiaries under the will.

The New Jersey inheritance tax is imposed on certain bequests based on the relationship between the deceased and the beneficiary, and the value and nature of the asset transferred. The tax is also levied on transfers within three years of death.

There is no inheritance tax imposed, if the beneficiary is a spouse, domestic partner, civil union partner, grandparent, parent, descendant, stepchild of the decedent, or a charity. If the beneficiary is in one of these categories, the value or nature of the bequest doesn’t matter. If the beneficiary does not fall within one of these categories, then the relationship to the beneficiary and the value or nature of the bequest will be considered to see if there is an inheritance tax.

Transfers to a sibling, son-in-law or daughter-in-law (“Class C” beneficiaries) aren’t taxable up to the first $25,000. Transfers in excess of that to $1.1 million are taxable at 11%. Transfers in excess of $1.1 million and up to $1.4 million are taxed at 13%, and transfers over $1.4 million up to $1.7 million are taxed at 14%. Any larger transfers are taxed at 16%.

Any other beneficiary falls into the “Class D” beneficiary category. If the value is greater than $500 to $700,000, transfers are taxed at 15%, and anything higher than $700,000 is taxed at 16%. Certain other assets, including public employee benefits (like those for a teacher, firefighter or police retirement fund) are exempt from these taxes.

Reference: (March 26, 2018) “Do the beneficiaries of life insurance have to pay inheritance tax?”