Life Insurance Benefits

• Life insurance pays the beneficiary an agreed upon sum of money when the person insured by the policy dies. There are two kinds of life insurance: term life and whole life. Term life insurance is in force for a specified period of time. If that time period ends and the insured is still alive, the payments to the policy are lost. Whole life insurance remains in force for the entire life of the insured, paying its benefits no matter when the insured dies.
  
  

Insurance Benefits and Taxation

• In the United States, insurance benefits are not taxable as income. This applies to all kinds of insurance, including auto and homeowner's insurance as well as life insurance. Whatever money is paid to the beneficiary will not be taxed. Likewise, life insurance policy payments are not a tax-deductible expense.
  
  

Estate Exception

• Most insurance policies pay to the estate of the deceased if the beneficiary dies first. This is most common in situations where two spouses, who have named each other as beneficiaries, die at the same time. Another common occurrence is when the second spouse dies never having changed the beneficiary upon the death of the first spouse. Insurance benefits that become part of the estate are subject to estate and death taxes before being disbursed to the inheritors.
  
  

Investment Exception

• Some life insurance policies, such as variable life and universal life, include an investment element. The value of the policy is tied to the performance of certain market indexes. In some cases, capital gains to the cash value can become taxable. Like most investment gains, this only applies once the policy is cashed in.
  
  

Other Wrinkles

• Tax law is complex and every rule has many exceptions. For example, some policy premiums can be purchased with pre-tax dollars under special circumstances. Like a retirement account, the benefit of such a policy may become taxable. It's best to consult with a professional during estate planning to make sure there are no surprises later on.