What Taxes Do I Pay On Life Insurance? 
Generally , none if proper steps are taken . Life insurance death benefit proceeds received by a beneficiary are income tax-free in most cases . This is a key feature of life insurance . Common exceptions include business-owned life insurance issued , or materially modified , after August 17 , 2006 which may be taxable unless specific steps are taken during time of application and annually thereafter to meet conditions which allow the proceeds to be income tax-free . Another exception is a tax trap where life insurance contracts with three parties involved may also have unexpected taxable implications . Beyond the death benefit tax-free characteristics , the cash values have important tax aspects as well . Cash value builds free of tax . If the policy-owner accesses cash values via withdrawals of some of the cash value -LRB- after policy year 15 -RRB- , the amounts are income tax-free return of basis -LRB- premiums paid -RRB- in the contract . After that , the gain would be income taxable . Special tax rules exist for distributions in the first 15 policy years . If the policy-owner accesses cash values by taking a policy loan , the amounts would be income tax-free . As long as the policy is not lapsed prior to the net death benefit being paid , the policy loans are never taxed . If there is a large loan and the policy is allowed to lapse , income tax would be due that year on all of the gain in the contract . In the event of a full surrender of the policy for its cash value , there would be income tax to the extent of gain in the contract . 