When Life Insurance Isn’t Tax-Free: 6 Situations That Create Tax Liability

Life insurance has earned a well-deserved reputation as one of the most tax-advantaged financial vehicles available. The ability to grow cash value. While life insurance payouts are usually tax-free, there are key exceptions that can trigger unexpected tax liability. Here are 6 situations to watch for in 2025: The three-party rule (different owner, insured, and beneficiary) Selling or transferring a policy for value Corporate-owned policies with improper documentation Interest earned on delayed death benefits Modified Endowment Contracts (MECs) Policy loans or withdrawals exceeding cost basis Understanding these scenarios helps protect your beneficiaries from surprise tax bills. Always consult a tax advisor or financial planner when structuring large or complex life insurance policies.