Taxation on Whole Life Insurance

by Rod Howell ; Updated July 27, 2017
The IRS can tax your whole life insurance benefits.

A whole life insurance plan is one of two types of permanent life plans that can be bought in the United States, along with universal life. Typically, whole life insurance benefits are not considered taxable income by the IRS. However, there are situations where money received from a whole life policy can be considered taxable compensation.


Whole life and universal life insurance policies are equipped with a cash value account. This tax-deferred feature enables the money earned over time to grow tax-free until it is withdrawn by the policy owner. Policy owners are able to take out policy loans if there is enough money in the cash value account. The money can be borrowed without any restrictions, and doesn’t have to be repaid. However, the final payout will be reduced by the outstanding amount.


A whole life insurance policy earns value over time. The insurance company invests a portion of the premiums into the market and gives the policy owner a minimum rate of return. This amount can increase if the insurer’s investment performance does well. If the insurance company makes a profit, they can share it among their policy owners in the form of dividends. Only policy owners of participating policies are eligible for dividend payments.


Most whole life insurance policies are individually owned, and premiums are paid with after-tax dollars. Therefore, the insurance benefits received by the beneficiary will not be considered taxable compensation. However, there are some instances of taxation involving whole life insurance plans. If the policy owner doesn’t pay the policy loan back and their plan is canceled, the amount outstanding can be considered a "gain" and the insurer will report it to the IRS as taxable income. Dividends received by the policy owner can also be taxed if the amount exceeds what the policy owner paid in premiums.

Estate Tax

Whole life insurance benefits can be taxed as part of the policy owner’s estate. The policy will be included as part of the policy owner’s property and the value may push the estate’s worth over the federal estate tax limit. As of 2010, estates that are worth over $3.5 million will be taxed as much as 45 percent, according to the IRS. To avoid estate taxes, a policy owner will have to transfer ownership to another person, such as an adult child. Also, policy owners must not designate their estate or themselves as the beneficiaries. These changes must be made three years before the policy owner’s death to avoid estate inclusion.


Whole life insurance policies offer little flexibility when it comes to paying premiums or the values of the plan. Policy premiums must be paid on time or the policy will lapse. Policy values such as benefit amounts, minimum interest rates and investment options cannot be changed once agreed to during the application process.

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