Understanding the Tax Implications of Your Life Insurance Policy

Life insurance policies are known for their tax advantages. Under certain conditions (such as the amount of withdrawals and the age of the policy), they can provide partial—or even total—tax exemption. Similarly, life insurance greatly simplifies the transfer of assets to the policy’s designated beneficiaries. Discover everything you need to know about the tax implications of your life insurance in our guide!

Life Insurance in a Nutshell

Life insurance is a savings product offered by an insurer, whose main purpose is to diversify and grow your assets. It allows you to invest in a variety of euro-denominated funds or unit-linked funds (ETFs, real estate investment trusts [SCPIs], corporate bonds, etc.).

As an investor, your primary goal is to strike the right balance between investment safety and rate of return. To that end, you can draw on the expertise of Raizers’ advisors to help you identify the investment vehicles that best align with your strategy and risk tolerance.

One of the main advantages of life insurance is its tax treatment, which is generally considered favorable. Depending on how long you’ve been making payments into your policy and the amount of withdrawals (known as “surrenders” in financial jargon), the tax rate will be higher or lower.

What are the tax implications of a life insurance policy?

Under a life insurance policy, only the gains (interest and realized capital gains) are taxable in the event of a partial or total surrender. This model is therefore considered particularly attractive because it enhances the compounding effect. Keep in mind that the interest earned in a given year will, in turn, generate interest, and so on, throughout the term of the policy. This creates a virtuous cycle for your savings, allowing you to maximize your returns without any special effort.

It is only when you decide to make a withdrawal (partial or total) that your earnings are subject to some form of taxation. The rate applied by the tax authorities then depends on two major factors: 

• the date the premiums are paid;
• and the amount of redemptions made.

Premiums Paid Before September 27, 2017

Contributions made before September 27, 2017, are subject to a special form of taxation. If you are making a withdrawal from one of these plans, the earnings are taxed as follows: 

• 17.2% in social security contributions; 
• A 7.5% flat-rate withholding tax (PFL) OR application of the progressive income tax scale.

Premiums Paid After September 27, 2017

Payments made after September 27, 2017, are subject to a different form of taxation. This varies depending on the amount of premiums paid and the age of the policy. Keep in mind that the most advantageous option applies to redemptions of premiums that are more than 8 years old and amount to less than 150,000 euros. 

For more details, please see the table on the right: 

Life Insurance Policy: Tax Deduction and Exemption in the Event of Partial or Total Surrender

In certain specific cases, it is possible to receive a tax deduction on a portion of the gains realized, just as it is possible to qualify for a total exemption from income tax.

When are you eligible for a tax deduction?

There is a specific scenario in which you may be eligible for a tax deduction on earnings generated through your life insurance policy. Specifically, if your taxable income for the year N-2 is less than €25,000 (€50,000 for jointly filed returns), then you are not subject to the non-final flat-rate withholding tax (7.5% or 12.8%, as a reminder).

When are you eligible for an income tax exemption?

In the event of a partial or total surrender of your life insurance policy, you may be eligible for an income tax exemption if, and only if: 

• you are facing termination;
• you are facing bankruptcy proceedings;
• you are eligible for early retirement;
• be classified as a Category 2 or 3 disabled person.

If any of these situations apply to you, then an exemption may be possible. Note, however, that in the case of a full buyout, the transaction must be completed before the end of year N+1.

Why does a life insurance policy make it easier to pass on an estate?

As its name suggests, a life insurance policy is designed to simplify the transfer of assets following the policyholder’s death. Its main advantage is that the designated beneficiaries of the policy are completely exempt from estate taxes, if and only if they are: 

• the surviving spouse (or civil union partner);
• siblings (under certain conditions).

For any other beneficiary, the tax treatment of the transfer of assets will depend primarily on two factors: the policyholder’s age at the time of the payments and the amount of the taxable portion after the deduction.

Tax deduction for premiums paid before the policyholder turns 70

If premiums were paid before the policyholder turned 70, the tax authorities provide for a deduction of 152,000 euros per beneficiary. This is a substantial amount, which contributes to the popularity of life insurance policies as a means of transferring wealth.

If the amount paid to a beneficiary exceeds 152,000 euros, the tax authorities apply a flat tax rate: 

• 20% for any taxable portion less than 700,000 euros;
• 31.5% for any taxable portion exceeding 700,000 euros.

Tax deduction for premiums paid after the policyholder turns 70

As for payments made after the policyholder turns 70, the situation is less favorable. In this case, there is no longer a 152,000-euro exemption per beneficiary, but rather a single exemption of 30,500 euros.

The remaining capital is then reintegrated into the estate’s assets and is, of course, subject to estate tax at the progressive rate. It should be noted, however, that capitalized interest is exempt from taxation.

A Closer Look at the Lifetime Annuity Option

There is an alternative option for distributing the proceeds of your life insurance policy: a life annuity. This is an attractive option, particularly when you retire, as it provides a significant source of supplemental income.

In practical terms, this solution requires your insurer or distributor to pay you an annuity until your death. This annuity can be paid monthly, quarterly, or semiannually. However, a life annuity has two important implications: 

• you lose control of the accumulated value in your life insurance policy;
• You agree to refuse the transfer of your contract following your death.

How are life annuities taxed?

A life annuity is subject to income tax and social security contributions. However, the taxable portion varies depending on your age at the time the first annuity payment is made: 

Which is more tax-advantageous: a PEA or a life insurance policy?

The PEA (stock savings plan) is an investment vehicle that can be viewed as an alternative to or a complement to life insurance. Generally speaking, it is often considered slightly riskier due to its higher volatility, which is why it is favored by investors seeking performance and returns.

From a tax perspective, the PEA offers an undeniable advantage: total exemption from income tax after holding the investment for 5 years. However, you must continue to pay social security contributions, which are taxed at a rate of 18.6%.

On the other hand, a life insurance policy offers much greater flexibility when it comes to transferring assets in the event of the policyholder’s death. The transfer of savings is streamlined and follows relatively simple rules, whereas a PEA necessarily involves transferring the deceased’s securities to a securities account in the heirs’ names, who then have the choice of selling or retaining them. Furthermore, their value is directly included in the estate’s assets—and, as a result, is subject to estate taxes.