Just a question, as I try to get all the crap that I have to deal with after my mom’s death finished and done with. Is a lump-sum life insurance payout taxable (either federal or state income tax)? Do I need, in addition to paying the funeral home and dividing what’s left with my brother, to hold back 28% or whatever to cover next April? If so, will I need to hold back that amount on the whole sum or just the part that I don’t give to either the funeral home or my brother? Will my brother need to hold back a percentage of what I give to him?
I am going to call the issuer soon (either tonight after work or early next week) to ask questions like “Do we both have to submit a claim or can it be only one of us and any division done privately?” and “How long is it likely to take, because the funeral director is over there tapping his foot waiting to get paid for the (sincerely excellent) work he did?”
In general, insurance payouts are not taxable. As for getting the money, you will need to send documentation of the death to the company and they will write the necessary checks to whoever is named as the beneficiary. If you are the only beneficiary, and you give some of the money to your brother, then that may be subject to gift tax on your end. Definitely consult a tax expert if that’s the case. But if you are both named as beneficiaries, there should be no problem. The insurance company will take care of it.
ETA: Remember also that life insurance is entirely separate from the probate process; the insurance money is paid directly to the named beneficiary. The exception is if the dead person’s estate is named as the beneficiary.
As I know it, the money is yours free until it makes it’s own interest. My experience was the insurance company paid out quickly upon seeing a death certificate. They want to get the thing off their books with some justification for doing so. You sign a disclaimer saying that you are truthful. It’s the easiest part of an estate.
If that’s the case isn’t that a good way to avoid estate taxes? Let’s say some octogenarian billionaire buys a 10 million dollar life insurance policy. It probably sets him back just over 10 million dollars based on actuarial tables. That’s money transferred directly from his estate to his beneficiaries without taxation. Does a policy have to be held a certain length of time for benefits to be non-taxable?
Life insurance policies are one of the ways used to pass money to heirs without estate taxes keeping a chunk, and there are lots of variations on how it’s done. For example, irrevocable trusts may be set us as the beneficiary of an insurance policy. Life insurance is also frequently used to generate the cash to pay estate taxes so that no assets need to be sold off.
I think you’re underestimating the actuarial cost of life insurance. You have to consider both the premiums and the investment income that can be earned on those premiums. If that wasn’t true, life insurance companies would be buying the policies rather than selling them.
There are rules in place to prevent people from doing just that. An insurance policy such as you described would be categorized as a Modified Endowment Contract and the proceeds would be subject to taxes, taking away the incentive to fund such a policy.