Tax Treatment of Life‑Insurance Interest: What You Need to Know

Interest earned on a life‑insurance policy is generally taxable as ordinary income, unless the policy qualifies as a tax‑free cash‑value accumulation vehicle such as a whole‑life or universal‑life policy that meets IRS 7702 criteria. If the interest is paid out or credited to you, you must include it on your tax return, typically on Schedule 1 of Form 1040.

When Interest Is Taxable

Most policy‑holder accounts that earn interest, such as savings‑type life insurance or a cash‑value component that is not a qualified contract, produce taxable interest. The insurer will issue a Form 1099‑INT reporting the amount, and you must add that figure to your taxable income.

When Interest May Be Tax‑Deferred

Policies that are classified as "life‑insurance contracts" under IRC § 101(a) and meet the cash‑value test (often called "qualified" policies) allow the cash value to grow tax‑deferred. In those cases, interest and other earnings are not reported until you withdraw them, surrender the policy, or the policy lapses.

Reporting Requirements

1. Receive Form 1099‑INT from the insurer.2. Enter the interest amount on Schedule 1, line 8z, of Form 1040.3. If the policy is surrendered, report any gain as ordinary income on Schedule D.

Special Situations

Policy loans are generally not taxable because they are considered borrowing against the cash value, not a distribution. However, if a loan exceeds the policy's cost basis, the excess may be treated as taxable income.

Key Takeaways

• Taxable interest: non‑qualified cash‑value policies, savings‑type life insurance.
• Tax‑deferred interest: qualified life‑insurance contracts meeting IRS 7702 rules.
• Report interest using Form 1099‑INT and Schedule 1.
• Policy loans are usually non‑taxable unless they exceed basis.