Taxes

Answers in the taxes topic.

• Is a life insurance payout taxable?

  Life insurance death benefit proceeds paid to a beneficiary by reason of the insured's death are generally not subject to federal income tax. There are important exceptions: any interest paid on the proceeds (for example if the insurer holds the money and pays it out with interest) is taxable; the transfer-for-value rule can make some or all of the proceeds taxable if the policy was transferred for valuable consideration; and if the insured owned the policy, the death benefit is generally included in the insured's taxable estate, so very large estates may owe federal estate tax.

• What is a modified endowment contract (MEC)?

  A modified endowment contract (MEC) is a permanent life insurance policy that has been funded too quickly under Internal Revenue Code rules — specifically, one that fails the '7-pay test' by receiving more premium in the first seven years than the IRS allows. Once a policy is classified as a MEC it is still life insurance (the death benefit is still generally income-tax-free), but withdrawals and policy loans are taxed differently: gain is treated as coming out first (LIFO), is taxable as ordinary income, and distributions before age 59½ may face an additional 10% penalty.