Types

• Term life and permanent life insurance are the two types of life policies available in the United States. Term life insurance plans cover the insured for a specific amount of time such as 5, 10, 20 and 30 years. Coverage ends once the term expires. Permanent life plans such as whole life and universal life can provide lifetime coverage for the insured. These plans earn value over time and are equipped with a tax deferred savings component called a cash value account. Term life insurance policies do not have a cash value account.
  
  

Policy Loans

• Permanent life insurance policy owners can take out a loan if they have money in their cash value account. Policy loans are paid out tax free. Loans are not required to be paid back. However, the death benefit will be decreased by the amount of the loan balance. If the policy is terminated or surrendered while the loan is outstanding, the money can be considered a gain and the insurer will report the loan as income to the IRS.
  
  

Benefit Payments

• Individual policy benefits are generally not considered for taxable income. However, group life policy benefits are taxable compensation if the amount exceeds $50,000. Spousal and dependant group coverage is also subject to taxation if the benefit amount is over $2,000. Employer-sponsored group term life policies that are valued over $50,000 will share the premium costs with employees. To calculate the employee's share, employers will use a Uniform Premiums Table created by the IRS. The amount will be reported on employee w-2 as taxable income.
  
  

Estate Tax

• The death benefit from a life insurance policy can be taxed as part of a policy owner's estate. An estate is the property owned by a person, which would include their life insurance policy. As of 2010, estates will be taxed up to 45 percent if the value exceeds $3.5 million. To avoid estate taxes, the policy owner must assign ownership of the policy outside of the estate. Any changes must be done three years prior to the death of the policy owner in order to avoid estate inclusion.
  
  

Modified Endowment Contract

• If policy owners are found to be 'pre paying' premiums, their life insurance policy would be labeled a Modified Endowment Contract (MEC). This will make distributions from the life insurance policy subject to taxation. Insurance policies are put through a 7-pay test period where premium amounts are averaged out over a seven year period. If paid premiums exceed the average, then the policy will become a MEC. Once a life insurance policy is labeled a MEC, it will remain a MEC.