Are Life Insurance Death Benefits Subject to Estate Tax?

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Life insurance proceeds are tax-free to some extent, but that isn't always the case. Death benefits aren't normally subject to income tax, but they can add to the value of the decedent's estate and become subject to the federal estate tax. That would occur if certain rules weren't met, and the overall value of the estate exceeds the annual federal estate tax exemption, which is $11.7 million in 2021.

Twelve states and the District of Columbia additionally impose an estate tax, and their exemptions can be much lower. They're only $1 million in Massachusetts and Oregon in 2021.

When Death Benefits Are Taxable

The death benefits paid on life insurance policies can be subject to an estate tax in two situations.

  • The whole amount of the death benefit is included in the estate and subject to estate tax if the estate is named as beneficiary.
  • The whole amount of the death benefit is included in the estate and subject to estate tax if the deceased both owned and was insured by the policy on their date of death.

Most people name individuals as beneficiaries, so the death benefit doesn't become part of their estate. The second consideration is usually what causes an estate to owe an estate tax.

Ownership of the Policy

An insurance policy is a contract between the owner of the policy and the insurance company. The terms of the contract provide that the insurance company will pay a death benefit to a beneficiary designated by the owner in exchange for the payment of premiums. Payment of death benefits is made as of the date of death of the insured.


The owner of a life insurance policy is not always the individual whose life is insured. You might purchase a policy on your spouse's life or a parent's life, for example.

The owner of the policy has all the lifetime rights to the contract. Some types of policies allow them to borrow against the policy, cancel the policy and receive the cash surrender value, designate a beneficiary, and exercise any policy options for the application of dividends or conversion features during their lifetime.

The Unlimited Marital Deduction

A spouse would typically be the owner of a policy if they bought life insurance on their own life. That individual's life is insured, and the other spouse is named as the primary beneficiary. Their children might be contingent beneficiaries, to receive the benefits if the surviving spouse were also deceased. That might be the case if the parents died in a common event, for example.

The death benefit would be paid to the surviving spouse if the owner/insured spouse were to die first, and the full value of the death benefit would be included in the deceased's estate because this individual owned the policy. But it's not taxed in this situation, because it qualifies for a tax provision known as the "unlimited marital deduction."


The unlimited marital deduction covers the value of all property that passes to a surviving spouse. There's no estate tax payable until the death of the survivor. The estate would not be taxed twice, first as it passes to the surviving spouse and then again when it transfers to the surviving spouse's heirs.

The surviving spouse has access to these funds in this case, and it would not be subject to an estate tax on this spouse's estate until the survivor dies. It wouldn't be subject to an estate tax if the benefits were spent by the time of the second death.

The death benefit would be included in the estate and would be subject to estate tax if it were paid to the children, because the father was the owner of the policy.

The full value of the death benefit is subject to estate tax if there's not a surviving spouse, either because the spouse predeceased the policy owner or because the decedent wasn't married at their time of death.

When Someone Else Owns the Policy

Benefits would be paid to the child upon the parent's death if the child took out the life insurance policy, or to any beneficiary the child designated. None of the death benefit would be be included in the parent’s estate and subject to estate tax in this case, because the decedent didn't own the policy.


Ownership of life insurance policies is an important factor in how much estate tax is due, because the estate tax rate can be considerable. It would amount to saving $250,000 in tax if the policy were for $500,000, and the estate were in the 50% estate tax bracket.

The Bottom Line

Changing ownership of a life insurance policy can be an important estate planning technique. It involves transfer of the policy, but this is considered a gift to the recipient. The value of the gift is referred to as the “interpolated terminal reserve value” of the policy. This isn't the cash value of the existing policy but rather what it would cost to purchase another policy with the same terms at the current time.


The interpolated terminal reserve value is a complex calculation that the insurance company will provide to you. It almost always works out to something equal to, or a bit more than, the cash value of the policy.

The original owner must survive the transfer by three years to succeed in removing the death benefit from the estate for estate tax purposes. The decedent is deemed to be the owner of the policy, and the full value of the death benefit is includable if the death occurs within three years of the transfer. 

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  1. Internal Revenue Service. "Life Insurance & Disability Insurance Proceeds."

  2. "Estate Tax."

  3. Tax Foundation. "Does Your State Have an Estate or Inheritance Tax?"

  4. Internal Revenue Service. "Publication 559 Survivors, Executors, and Administrators," Page 26.

  5. Internal Revenue Service. "Frequently Asked Questions on Estate Taxes: What Deductions Are Available to Reduce the Estate Tax?"

  6. Internal Revenue Service. "Rev. Proc. 2005-25," Page 6.

  7. Internal Revenue Service. "2104.02-00- Revocable Transfers and Transfers Within Three Years of Death," Page 2.

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