life insurance and taxes

[kidzndogz]

What is the name of your state? New Jersey
Hi again. I posted here in the summer about my grandfather having just passed. My grandmother received a check from his life insurance company at the end of July and has not yet cashed it. My first question is when does it expire (6 months or a year) and secondly, for tax reasons, is it better for her to deposit or cash the check now before December ends or should she wait until January?

 

[ALawyer]

Cash the check, NOW.

Life insurance payments are tax free to the recipients (unless the life insurance policy was "purchased" after issue from someone for investment purposes, such as with a viatical settlement or "senior settlement").

To the extent that the life insurance payment may have included "delayed settlement interest" -- some companies pay interest from date of death IN ADDITION to the death benefit, and others start to pay such interest after X days or after Y days from receipt of the claim form -- that delayed settlement interest is taxable as is ordinary interest. But the insurance company reports the interest when they cut the check. IF the claim was paid by use of a Retained Asset Account / Beneficiary Access Account, it continues to earn interest so long as any money remains on deposit with the insurance company.

 

[kidzndogz]

Just to make sure I get it

New Jersey

I know I am blonde but you are saying to cash the check now but from the rest of your response, I am understanding that there is interest being earned on the life insurance either from the time the company cut the check or from X amount of days after it was cut but not cashed. Does the interest go to my grandmother or are you saying the insurance company is benefitting each day the check cashing is delayed.
My grandmother is living on her social security as sole income so she just wanted to make sure whether to cash the check tomorrow (12/31) or to wait for tax reasons. Basically she wants to pay as little taxes as possible and she was told by another widow that she has to pay taxes on whatever portion of the insurance she keeps. If she pays for her own funeral, that portion is not taxable. I just want to make sure I understand the response before I try to explain it to grandmother. Thank you so much for your response and your patience.

 

[ALawyer]

One nice thing about the web is that one's hair color, and hair quantity, is irrelevant.

Let's assume the face amount of the insurance was $100,000, and the deceased died 6/30/05. As it takes a while to get the death certificates, let's say the death claim was filed on 7/31/05 and we'll look at two alternatives: 1) the insurance company issued its check on 8/15/05, and then alternative 2) the insurance company paid the claim through a retained asset account on the same date and sent her a checkbook instead of a check.

Some insurance companies pay interest from the date of death until they cut the check or put the money into the retained asset account. (Others do not, unless required to do so by state law, sometimes after a set time period, say 30 or 60 days from the time a claim is filed.)

Given the fact that interest rates now are reasonably low (assume 4%), IF the insurance company paid interest from date of death, the check it cut in alternative 1 would be for $100,000 PLUS 45 days interest at 4% which is $500, for a total of $100,500. That check does not bear interest, period. Whether she deposits it or not the insurance company would report to the IRS that it paid her $500 in interest in 2005. She gets the death proceeds of $100,000 income tax free, but may have to pay taxes on that $500 of interest; that depends on her tax rate and she adds it to her other income and if she has enough other income, it would be taxable on her 2005 return, whether she cashes the check or not.

Now IF the deceased's estate had exceeded $1.5 million (that goes up to $2 million for those who die on or after 1/1/06) and the deceased was not the beneficiary's spouse, there may be federal estate tax; generally insurance beneficiaries have to pay their share, but my guess is that's not her situation. (It's what some little old lady may have told her, in ignorance.)

Let's do alternative 2 -- if the insurance company paid the money thru a retained asset account, it would have placed the $100,000 (and if it paid delayed settlement interest, the hypothetical $500) into the account on 8/15/05, and that account would have started earning interest at once and will continue to do so until she takes the money out of the account. Each year it would report the amount of interest she earned to the IRS, just as a bank would. If she takes out some of the money, then there would be less left on which she'd earn interest, and thus less interest she'd earn.

 

[kidzndogz]

thank you both so much

Thank you both so much for your help on this matter. I am going to drive my grandmother to the bank tomorrow then to cash that check.