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Does Minnesota Tax Life Insurance Proceeds?

November 29th, 2022 by

When it comes to preparing your family for the unexpected, life insurance is a great way to be sure your family is taken care of, in the unlikely event of your sudden demise. But you don’t want to leave your loved ones with the burden of paying extra taxes.

This leads to the obvious question: Are federal and state taxes owed on beneficiary money from life insurance in Minnesota?

The answer? It depends. With careful planning, you can help minimize tax liabilities for your beneficiaries. 

Is Life Insurance Taxable in Minnesota?

Life insurance can work in many ways. There are different types of payouts, and different types of beneficiaries (or ways it can be paid out to designated persons). Taking some time when you set up your policy can save a mountain of headaches for those you leave behind.

In most states, the death benefit payout is not a taxable amount. Minnesota is no different. Generally speaking, the payout is not taxable income. This means your beneficiaries will not have to worry about such fees.

However, there are some circumstances where that may change. It takes careful planning, and occasional updates or “checkups” to your policies to ensure they stay that way.

When Would Taxes Be Owed?

If you are married and name a spouse as your 100 percent beneficiary, that spouse will not be subjected to income or estate taxes. But, in which cases might that change? 

1. If interest is accrued

Most life insurance payouts come in one, lump sum. However, if your policy opts to release the funds in payments, it may sit in an account before it comes to you. During that time, the funds may accrue interest.

Should this be the case, the one that receives the benefit of those interest payments would be responsible for paying taxes, but only on the interest built up over time.

2. If funds go into a ‘Taxable Estate’

In some circumstances, funds will first be transferred into a “taxable estate.” This is often the case if you do not update your files upon changes in deaths or named beneficiaries. 

For example, if you name Joe your beneficiary, but Joe has passed away since your last update, the funds will instead go into your taxable estate. It will remain there until the next of kin or inheritor is named.

This commonly happens for two reasons: the death of a beneficiary or no beneficiary is named specifically. To avoid those issues, keep your beneficiaries up-to-date.

3. Total Inherited Assets Top $1 Million

Let’s say you name your children your beneficiaries. In the state of Minnesota, that means they will be free from income tax on the payout. However, because the funds are then considered part of your “taxable estate” (see number two), they will be subject to taxes if the total estate tops $1 million in value.

4. Three Individuals Are Involved: A Goodman Triangle 

On occasion, it is not the insured person that purchased the policy. Instead, its premiums were paid monthly by another party. Let’s say for example a wife takes out a policy for her husband. She names their daughter the beneficiary to that policy. The wife is the “purchaser.” The husband is the “insured” and the daughter is the “beneficiary.”

These three unique roles, being served by three individuals, means that the government views a payout as a “gift” from the wife to the daughter. Sometimes dubbed the “Goodman Triangle,” this would subject the sum to taxes under the “gift” laws and regulations. 

Avoiding Life Insurance Taxes

One way many combat the burden of taxes on a life insurance payout is to establish an Irrevocable Life Insurance Trust (ILIT). THe ILIT allows for any life insurance payouts to NOT be considered a part of your estate, thus avoiding the taxable income factor.

Ideally, the trustee would purchase and pay premiums for the policy, avoiding any issue after the death of the insured.

How Do I Set Up A Tax-Free Policy?

If these terms have your head spinning, you are not alone. There is plenty to confuse the average person when it comes to insurance and taxes. To ensure that your loved ones are cared for, work with a professional.

Knowing those confusing ins and outs is my job, and I am happy to sort out a plan along with you to fit your unique needs. We can tailor the approach to fit you perfectly. Make an appointment today to find out more.

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