When it comes to insurance, taxation is often the subject of much contention. Here at Omega Insurance Group, we're frequently asked whether life insurance benefits are taxable in Nebraska. In general, the simple answer is no. However, some important exceptions do apply and are worth considering.
Life insurance is a financial support system for loved ones in the event of an individuals passing. It allows loved ones to maintain commitments, remain supported, and continue affording their cost of living despite your absence. Therefore, given that life insurance policies are basically lifelines to living beneficiaries, federal and Nebraska state law do protect life insurance payouts from taxation. Unfortunately, there are some exceptions, the following are a few examples of when Nebraska life insurance benefits become subject to taxes.
The default payment option for life insurance benefits is a single lump-sum distribution. Payments received in this settlement are generally tax-free; however, you and your beneficiaries may instead choose to receive this payment in multiple installments. If the sum total of these installments will be greater than if you had opted for a lump-sum payment, the additional amount will be considered as interest. This interest will then be subject to taxation.
A few situations also exist when a policyholder opts not to immediately receive the payout amount, but instead has the insurance company hold proceeds for a given period of time. If this applies to you, your beneficiaries may have to pay taxes for any interest earned during this holding period. Neither payout method is necessarily best, the most ideal settlement will often be determined by individual circumstances.
Some insurance policies have a cash accumulation feature, where aside from the death benefit payout, beneficiaries can also build value that can be received while the insured remains living. When one taps into this cash resource, it reduces the overall value and death benefit of the policy, and will also increase the chance of policy lapsing. Policy lapses can lead to policy termination before the death of the insured, and will therefore result in taxation. Thus, this feature is generally meant to function as a last-resort option to be used during emergencies.
In the event a life insurance policy is paid to an estate, its beneficiaries could be subject to taxation. It is worth noting here that Nebraska does not have an estate tax. However, while your estate may not be taxed, each of your estate's heirs or beneficiaries will likely be taxed during the transfer of property. Also, if your life insurance proceeds are receivable by the administrator of an estate, they will then be taxable.
That said, life insurance benefits will remain tax-exempt if paid directly to a living beneficiary or via an irrevocable trust. In order to keep your insurance proceeds out of your estate, consider transferring policy ownership directly to your beneficiaries. Another way to do this is to transfer ownership to an irrevocable life insurance trust, where your life insurance proceeds can be shielded from estate taxes.
We understand that insurance and taxes can be challenging and complicated on their own, let alone during the death of a loved one. Licensed insurance professionals can help simplify these processes, reducing the friction, difficulty, and negativity associated with such important proceedings. If you're worried about life insurance, taxes, or this process in general, we encourage you to request a free quote or contact us. We'd be happy to sit down together and discuss your specific needs and concerns before deciding on the perfect policy for you and your family.