Is Life Insurance Taxable for Beneficiaries?

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Life insurance continues to be one of the preferred means of providing for old age and protecting surviving dependents. However, one question always leads to uncertainty: When, where and how do life insurances actually have to be taxed? Does the taxation depend on the type of insurance? Or about when the insurance was taken out? Here we will answer the most important questions and give you a few tips – so that there are no unpleasant surprises in the form of tax deductions in old age.

The most important things in a nutshell

  • Term life insurance is used exclusively to protect relatives.
  • The payout is tax-free , inheritance tax can only be levied as soon as the exemptions are exceeded.
  • Endowment life insurance policies that were taken out before 2005 are usually tax-free as soon as the payment is made as a one-off payment.
  • In the case of endowment life insurance policies that were taken out from 2005 onwards, taxes are generally payable on the income.
  • If the benefits from a life insurance are paid monthly as a pension, these payments are always taxable, regardless of when the insurance was taken out.
  • If endowment insurance policies are terminated or sold prematurely, withholding tax must be paid on the income for all insurance policies.

What types of life insurance are there?

Endowment life insurance

Endowment life insurance serves both retirement provision and protection in the event of death. The relatives or beneficiaries are insured in the event of death. In addition, a capital stock is built up, which is used for old-age provision and can later be paid out as a monthly pension or as a one-off payment.

Term life insurance

The term life insurance is a pure death protection, which serves to protect the bereaved. If the insured person dies during the term, the sum insured is paid out to the registered beneficiary. If the insured person experiences the end of the contract, the insurance expires without any money being paid out.

Term life insurance is usually cheaper than endowment life insurance and is particularly suitable if you want to protect adolescent children or real estate loans. With the payment of term life insurance, for example, loans can be redeemed or the children’s education can be financed. Term life insurance is usually taken out for a certain period of time (e.g. until the children grow up or until the loans are paid off). For couples, it is advisable to take out a so-called “cross-over insurance” .

When is life insurance tax-free?

It depends on both the type of life insurance and the time at which the insurance was taken out whether or not a life insurance policy is taxable. We will explain here which life insurance has to be taxed when.

When does term life insurance have to be taxed?

Term life insurance is not taxable in the event of death . However, inheritance tax may apply to the amount if the allowances are exceeded. This can be avoided by taking out so-called term life insurance across the board. This means that the policyholder takes out term life insurance for the partner’s life and vice versa. In the event of death, the insurance is then paid out directly to the partner, there is then no inheritance tax. Be sure to consider inheritance tax issues before taking out insurance. This is particularly important for unmarried couples, for whom much lower tax exemptions apply in the case of inheritance than for married couples.

How much tax do I pay on my life insurance?

If the benefit is paid out as a one-off payment in the case of endowment life insurance, the withholding tax is automatically withheld from the payment as soon as the insurance has been taken out from 2005 onwards. Overpaid withholding tax may be claimed in the income tax return. There is an allowance of 801 euros per year and person.

There is a possibility that only half of the income has to be taxed. To do this, the following requirements must be met:

  • The contract period is at least 12 years . The sum insured is only paid out after the age of 60.
  • The death benefit comprised at least 50% of the contribution
  • The expiry benefit is paid out in full in one amount. In this case, instead of the flat rate tax, the personal income tax rate is payable on half the income. However, if the requirements are not met, the entire income must be taxed in the form of withholding tax.

Taxes if paid out as a pension

As soon as the endowment life insurance benefits are paid out as monthly payments, this life insurance pension must be taxed. This is regardless of when the contract was concluded. Only the so-called income portion of the payout is taxable, not the entire payout. It is not possible to determine in general how high the proportion of earnings is. This is regulated in the Income Tax Act . Among other things, the age of the pension recipient is decisive.

The insurance company takes over the calculation of the earnings share, this is then added to the personal taxable income and then taxed at the personal income tax rate. There is no automatic taxation in the form of withholding tax.

Taxes on sale or cancellation of a life insurance policy

It is possible to cancel a life insurance policy during the term. In this case, the insurance policy is returned to the insurer and the so-called surrender value is then paid out. The income from the disbursement (disbursement minus paid contributions) is then fully taxable in the form of withholding tax. The tax exemption of 801 euros per person can be used for income from investment income. This applies to all contracts concluded from 2005 onwards.

Another – often more lucrative – option is to sell the insurance policy to a third party. There is also a secondary market that deals in such insurance. In this case, the difference between the sales price and the contributions paid is taxable; here, too, the tax exemption of 801 euros per person can be claimed. This also applies to all contracts concluded from 2005 onwards ; contracts concluded previously can be sold tax-free.

Tax deductible life insurance costs

The monthly contributions for a life insurance can be deducted from taxes. This applies to all term life insurance . Up to a maximum of 1,900 euros per year , the contributions can be offset as pension expenses. In the case of endowment life insurance. However, it should be noted that since 2010 all contributions to health and long-term care insurance can be declared in full with the tax. If these amounts are higher than 1,900 euros (for employees) or higher than 2,400 euros (for civil servants), the contributions to endowment life insurance can then no longer be taken into account.

Also Read: Is Life Insurance Tax Deductible in 2021?