Is a California life insurance policy taxable?

Life insurance proceeds are not taxable at the federal level, including in California. This means that if you are the beneficiary of a life insurance policy in California and you receive a payout after the policyholder’s death, you generally won’t have to pay any federal income taxes on the money you receive.

However, there are some exceptions and special circumstances to be aware of. For example, if the life insurance policy was purchased as part of an estate planning strategy, the proceeds may be subject to estate tax at the federal level if the total value of the estate exceeds certain limits. Additionally, if the policyholder transferred ownership of the policy to another party within three years of their death, the proceeds may be subject to estate tax as well.

At the state level, California does not have an estate tax or an inheritance tax, so you generally won’t have to worry about paying state taxes on life insurance proceeds either.

It’s worth noting that if you choose to cash out a life insurance policy before the policyholder’s death, the proceeds may be subject to taxes if the cash value of the policy exceeds the total amount of premiums paid. In this case, you would be taxed on the difference between the cash value and the premiums paid, but only if the policy is considered a “modified endowment contract” (MEC) under IRS rules.

Overall, while there may be some exceptions and special circumstances, life insurance proceeds are generally not taxable at the federal or state level in California. However, it’s always a good idea to consult with a tax professional or financial advisor to understand your specific situation and any potential tax implications.

Asked January 21, 2013 by Frances Mangubat