Last Updated: 08/24/2017
Besides providing security and protection for your family in the event of your death, life insurance also offers several additional financial benefits. In fact, the tax-related benefits alone make life insurance a valuable asset to incorporate into your financial planning.
While a term life insurance policy will provide death benefit protection, permanent life insurance policies can provide a cash-value advantage on top of that. This has the added advantage of allowing the policyholder to accumulate a substantial amount of tax-deferred savings over the course of their policy.
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These are the seven tax-related advantages that are available to you if you have a permanent life insurance policy:
A non-taxed payout is available to anyone with a life insurance policy. Regardless of the type of policy you have, the death benefit is paid out tax-free. This means that your loved one will receive the full amount of the money you planned for them and can use it freely on whatever obligations, debts, or responsibilities that need to be taken care of.
*The only exception to this rule is for individuals or married couples with estates that are valued at more than the current year’s estate tax exemption.
Life Insurance can be used to reduce or avoid your estate’s tax obligations for future generations. If your estate’s value exceeds the current estate tax exemptions ($5.49 million per individual, $10.98 million for married couples), life insurance can provide a tax-free influx of money at the time of your death.
By creating an irrevocable life insurance trust, you can separate the value of your life insurance policy’s death benefit from the value or your estate. This allows all of your hard-earned assets to be passed on untaxed to your loved ones.
Life Insurance is commonly used to leave a tax-fee inheritance behind to loved ones. Unlike a will, the proceeds of a life insurance policy can be paid out directly, and anonymously, to your beneficiary. This prevents jealously or in-fighting from your surviving family, and it also provides you with complete control of where your money goes.
Most life insurance policies will allow four or more beneficiaries, and you are able to assign a percentage of your death benefit to each beneficiary.
This advantage is exclusive to permanent life insurance policies; the growth in the cash value of the policy is not taxed until it is withdrawn. So the growth is able to keep increasing substantially year after year until you decide to withdraw it. And when you do make that withdrawal, the gains are taxed as regular income.
However, if you don’t take out the cash value before death, the amount and its dividends remain with the insurance company; and in that case, just the death benefit is paid out to the beneficiary.
Depending on your insurance policy, your dividends may be regarded as a return of policy premiums. This means your dividends may even be tax-free and would not be required to be reported on your tax return. These dividends can be used at your discretion to pay your policy premium or for purchasing additional insurance amounts. However, if your dividends exceed the net amount of the premium that has been paid into your policy, they may become taxable.
Like the tax-deferred growth, upon your death, the cash value—including dividends—would be absorbed by the insurance company if not used. The policy’s death benefit would still be paid out tax-free to your beneficiary. In some cases, the death benefit amount is included in your overall estate value and may be calculated as part of your estate tax as explained above.
Many times, you can use the cash value from your permanent life insurance policy to secure a policy loan. This requires contacting the insurance company directly. Because your loan will solely be based on the cash value of your policy, your coverage is protected as long as you repay the loan. There are no fees, charges, or taxes due with a policy loan because you’re not actually withdrawing money or receiving a distribution.
However, you can expect to pay interest on the loan, and that interest is not tax deductible. The interest rates can vary but are typically lower than what you would find at a bank or other lender.
A policy loan may be advantageous if you do not qualify for a standard loan or need to pay off a high-interest debt. But keep in mind that any unpaid loan amount at the time of your death will be paid off using the death benefit, which would decrease the amount of money paid to your beneficiary.
When it has an adequate cash value, you can actually withdraw cash out of the policy, tax-free. To do this, you would typically have to contact your insurance company directly. The withdrawal amount can be as much as your “basis”—the amount you’ve already deposited into the policy through your premium payments.
If you take out more cash than your basis, it’s viewed as withdrawing your gains, and is taxed as regular income. Typically, your insurance company will view any withdrawal as coming out of your basis first, before treating it as coming out of your gains. So if your cash withdrawal is for $20,000, and $15,000 is of your basis, then the first $15,000 would be withdrawn tax-free; any amount above that would be taken out of your gains and taxed.
You also have the option to withdrawal cash as a “cash surrender.” This means that you cancel your policy at the same time you take out the cash value for it. Typically there’s a surrender fee—which is dependent on how long you’ve owned the policy—even if you’re taking out just the basis of your policy. You can avoid the surrender fee by borrowing the money using a policy loan or simply not cancelling your policy.
A life insurance plan can clearly provide more financial security than simply providing your loved ones with a death benefit. The many tax advantages available for cash-value and permanent life insurance policies can make them an excellent tool when you’re planning your finances. Understanding these features and getting the most out of your policy can benefit you in a variety of ways, including making it easier to supplement your income, pay for college tuition, or pay off a large debt or mortgage.
Many of our retired clients are using their policies for cash when the funds from their retirement accounts or social security are not enough to cover their lifestyle and expenses. The cash values of their permanent policies are tax-free, and there are no early withdrawal fees (like they would incur with IRAs and many other retirement accounts).
Our agents at Term Life Advice are experienced and knowledgeable enough to help you take advantage of the tax-free benefits that come along with having a life insurance policy. We work with more than 60 top-rated insurance companies to help you find the best policy for your family and needs. We can work with you beyond that to help you use the tax-related features and benefits of your life insurance policy while you’re still alive. Give us a call, toll free, at: 855-902-6494 or use the free online quote tool below to get started today.