I recently wrote a blog post on tax on life insurance payouts and wanted to confirm that my understanding is correct.
If the insured person and the insurance payer are the same (e.g. I'm paying for my life insurance and my family will receive it), then lump sum payments get taxed as inheritance.
If it is an annuity/pension type (monthly payments), then it gets taxed partially as inheritance, and partially as misc income. This is the more complicated part.
At the time of death, the equivalent value is calculated. It is the highest of these 3:
- Surrender value (how much the insurance company would pay if we would cancel the contract)
- Lump sum value (if the contract allows you to ask for a lump sum payment instead of the monthly payments)
- Present value using the base annual interest rate of NTA (pro-rate the value of future payments using the interest rate)
Option 1 and 2 depend on the insurance company and might not be available (or might be lower than the third).
Option 3 is calculated with this formula (r is the interest rate, n is the number of years), for e.g. 10 years and 2% interest:
(1-(1/(1+r)^n)) / r = (1-(1/((1.02)^10)))/0.02 = 8.98
So for e.g. an 18 million yen overall payout (150,000 yen per month for 10 years) the inheritance tax is paid on 8.98*1,800,000 = 16.16 million yen. This is 89.77% of the whole payout (18 million), so the taxable portion is 8% (from this table), 1.44 million yen (8% of 18 million).
This 8% is divided among the 10 years of payments following this method: first year: no tax, second year: 1 unit, third year: 2 units, … 10th year: 9 unit. This overall means 1+2+…+9=45 units, so each unit is 1,440,000/45=32,000 yen. This is the portion that gets taxed as misc income in each year of the payout. So in the second year the taxable amount is 32,000 yen, next year 64,000 yen, then 96,000 yen and so on. In the last year it is 288,000 yen. This gets taxed as misc income at the marginal tax rate of the receiver.
Is my understanding correct?
by szabo_jp