Life insurance proceeds are generally not taxable to the recipient. The theory behind this is that the person who bought the life insurance paid the premiums with money that they had already paid income tax on.
The IRS writes, in Publication 525, that “life insurance proceeds paid to you because of the death of the insured person aren't taxable unless the policy was turned over to you for a price. This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract. However, interest income received as a result of life insurance proceeds may be taxable.”
So if you receive money as a result of being a beneficiary on someone’s life insurance policy, you are not going to have to pay tax on it.
What if you end up giving some of that money to other relatives? Will they be taxed on it? Nope! Once that money is awarded to you as beneficiary, it becomes your money to do with as you please. If you choose to give it to others, it becomes a gift. They would not owe tax on it nor would you owe tax in giving the money to them, although if the amount you give is over a certain limit, you might need to add an additional form, Form 709, to your tax return.
Generally, gifts are not considered taxable income to the person who receives the gift. To clarify: if Person A does work for Person B and Person B pays $1,000 to Person A, then that money is considered wages and is subject to being taxed just like the money earned by Person A at his/her job. If Person B gives a gift of $1,000 to Person A, then Person A doesn’t pay tax on the money.
If gifts given are over certain amounts ($15,000 in 2020), they could require that IRS Form 709 be filled out by the giver, and potentially that the giver pay tax if in the (extremely rare) case the giver has already given away more than the basic lifetime exclusion amount ($11.58 million if single or $23.16 million in 2020). However, the recipient of the gift would not have to pay tax on it; tax on gifts is the responsibility of the giver in the rare event that the giver is wealthy enough that tax would be required. To emphasize, unless you are SO RICH that you’ve already given away like $12,000,000 to people, giving gifts of any amount is not taxable to you or the person you are giving them to. You’d fill out a special form (709) if the amount exceeds limits, but no tax is due.
If you have received a life insurance payout, it is likely because someone who loved you and who you loved back has died, which is sad. However, the money that you receive from that loving person is a testament to how much they cared about you in life, and that enduring love is a lasting comfort.
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Kathryn Hauer, a Certified Financial Planner™, adjunct professor, and financial literacy educator, has written numerous articles and several books including the “11-Step, DIY, Comprehensive Financial Plan Workbook” and “Financial Advice for Blue Collar America.” She works to help clients and readers understand and act on complex financial information to keep them and their money safe. She functions as a strong advocate and guiding light for her clients as they move through murky and unfamiliar financial and career worlds.