Benefits In Excess Of Stated Amount

• Some types of life insurance accrue a cash value, receive dividends, or in some way cause the amount of money received at the insured person's death to exceed the face amount of the policy. For example, the policy benefit is $100,000 but you receive $101,000. In this case, only the extra $1,000 is taxable income.
  
  

Interest/Dividends

• Life insurance dividends are not taxable income and do not need to be reported to the IRS. However, interest received from the dividends, or from the policy itself, is considered taxable and must be reported to the IRS.
  
  

Estate Taxes

• Life insurance is often used to offset the cost of estate taxes, but restrictions apply. The policy must not name the deceased or his estate as a beneficiary, or the proceeds will be subject to the estate tax. In addition, the deceased must not have any incidents of ownership over the policy. The most common way to avoid incidents of ownership is to have the policy owned by a trust and maintained by a trustee other than the insured person.
  
  

Policy Loans

• For policies that accrue cash value over time, loans may be taken against the policy free of taxation at any time. If the insured person dies while a loan is outstanding, the death benefit will be reduced by the amount of the loan, and no taxes shall apply to the benefit. However, if the policy lapses with an outstanding loan, the loan amount can become taxable income.
  
  

Policy Withdrawals/Forfeiture

• An insured person may terminate an insurance contract at any time, in whole or in part. When you do this, the associated cash value of the policy becomes yours. If the amount of the cash value exceeds the amount of premiums paid (your "cost basis"), then the excess is considered taxable income.