Life insurance is usually marketed as “tax-free.” That’s mostly true, but not always. As a starting point, death benefits are generally not subject to income tax. That’s what makes life insurance such a useful planning tool, both for individuals and businesses. Where people get tripped up is everything around that baseline rule.

If the insurer pays the proceeds over time instead of in a lump sum, any interest component is taxable. That’s a common miss. The principal stays tax-free, but the earnings do not.

There’s also the “transfer-for-value” issue. If a policy is sold or transferred in certain contexts, the tax-free nature of the payout can be partially lost. This tends to come up in business deals, restructuring, or when policies change hands for consideration.

On the business side, corporate-owned life insurance (COLI) adds another layer. Companies often use these policies for key employees, buy-sell planning, or long-term funding strategies. The upside is still there, death benefits can remain tax-free, and the policy can grow on a tax-deferred basis, but only if the structure is handled correctly. One of the biggest pitfalls is failing to comply with notice and consent requirements. If those aren’t followed at the outset, the IRS can treat the proceeds as taxable. That is a fixable issue early on, but a painful one after the fact.

Cash value policies also create planning opportunities, but they need to be approached carefully. Growth inside the policy is generally tax-deferred, and loans can be taken without triggering tax. But if withdrawals exceed what was paid into the policy, that excess can become taxable income.

Another point to keep in mind is how these policies are used in practice. In corporate settings, life insurance is often tied to broader compensation or succession planning strategies. That makes the tax treatment less about the policy itself and more about how it fits into the overall structure. Small mistakes in setup (especially around ownership or compliance) can change the tax result entirely.

What this means

Life insurance is still one of the more tax-efficient tools out there, but it is not automatic. For individuals, the key is understanding that “tax-free” applies to the core benefit, not necessarily everything attached to it. For businesses, especially those using COLI, the value is real, but so is the compliance risk. If the policy isn’t set up correctly on day one, the intended tax advantages can disappear quickly. The takeaway is simple: the structure matters just as much as the policy itself.

Today’s Navigation is a series of articles by Weiss LLP to help individuals and businesses “navigate” today’s personal and business climate. Contact Weiss LLP for more information.