Is a California life insurance policy taxable?
UPDATED: Jan 21, 2013
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Asked January 21, 2013
Whether or not the proceeds of a life insurance policy will be taxable in the state of California will depend on how the policy was written. Some policies will pay directly into the estate of the deceased, while other policies will pay direct to beneficiaries and still others will deposit the proceeds into a trust fund or other type of managed account. Which method your policy is written to match will determine not only whether it is taxable but how taxation will be applied to it.
If the policy is paid into the estate of the deceased, then the beneficiaries would inherit their portions from the estate. In that situation, the life insurance settlement will be taxed as part of the estate. This method also leaves the settlement value vulnerable to seizure for taxes or other debts. Beneficiaries will receive their designated portions only after the estate is settled, which could be much less than the expected value.
If a whole or term life insurance policy names one or more individuals as the beneficiaries, the payout will not be taxable as part of the estate. This method could leave the beneficiaries vulnerable to collections, including personal and business back taxes, spousal support, and other debts.
Having a life insurance policy written to pay into a trust or annuity generally reduces or eliminates taxation on the payout. Since the money is only paid out to the beneficiary in small or timed amounts, the taxable amount, if any can be regulated. This method preserves the greatest portion of the policy payout. Trusts can also be set up to pay bills or mortgages directly, completely bypassing the taxation of the policy value.
Answered January 21, 2013 by Anonymous