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Taking Care of Mom and Dad: Insurance, Annuities, Etc.

The proceeds from a dead person's life insurance policy paid by reason of his or her death generally are excluded from income. The exclusion applies to any beneficiary -- whether a family member or other individual, a corporation or a partnership.

Life insurance proceeds paid to your parents because of the death of the insured policyholder are not taxable unless the policy is turned over to them for a price.

Your parents can exclude from income accelerated death benefits they receive on the life of an insured individual if certain requirements are met. Accelerated death benefits are amounts received under a life insurance contract before the death of the insured. These benefits also include amounts received on the sale or assignment of the contract to a viatical settlement provider.

If your parents receive life insurance proceeds in installments (as sometimes happens to beneficiaries of annuities), they can exclude details of each installment from their income.

If each installment they receive under the insurance contract is a specific amount based on a guaranteed rate of interest, but the number of installments they will receive is uncertain, the part of each installment that they can exclude from income is the amount held by the insurance company divided by the number of installments necessary to use up the principal and guaranteed interest in the contract.

If, as the beneficiary of an insurance policy, your mom is entitled to receive the proceeds in installments for the rest of her life without a refund or period-certain guarantee, she'll figure the excluded part of each installment by dividing the amount held by the insurance company by her life expectancy.

Example: As beneficiary, your mom chooses to receive the $50,000 proceeds from a life insurance contract under a life-income-with-cash-refund option. She is guaranteed $2,700 a year for the rest of her life (which is estimated by use of mortality tables to be approximately 25 years). The actuarial value of the guarantee is $9,000. The amount held by the insurance company, reduced by the value of the guarantee, is $41,000 ($50,000 - $9,000) and the excludable part of each installment representing a return of principal is $1,640 ($41,000 divided by 25). The remaining $1,060 ($2,700 - $1,640) is interest income to your mom. If she should die before receiving the entire $50,000, the refund payable to the refund beneficiary is not taxable.

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