Most people probably don’t think about life insurance policies when tax season rolls around, but perhaps they should. Life insurance, in particular whole life insurance, can help you and your beneficiaries take advantage of some tax benefits often overlooked by policyholders.
The advantages outlined here are particular to whole life insurance policies. It’s possible for other kinds of insurance to have some of these features as well… but it’s not a given. The Death
- Benefit Is Generally Paid Out Income Tax Free
That’s a pretty straightforward advantage for your beneficiaries. Life insurance policy payouts can be pretty hefty and avoiding a major tax bite can be consequential. By contrast, the government will typically tax most retirement plan proceeds when taken by beneficiaries.
There are instances where federal and state estate taxes can kick in on the proceeds of a life insurance payout, depending on particular circumstances. If your life insurance policy is part of a large estate, talking to a financial professional might be worthwhile to learn how to exclude your policy from your taxable estate.
- The Total Cash Value Accumulates On A Tax-Deferred Basis
Whole life insurance builds up cash value over time as you pay premiums. This is money that grows with added return without the IRS taking a bite. The result translates to policies becoming an important nest egg option for your future.
- You Can Access The Cash Value Of The Policy On A Tax-Advantaged Basis
Money borrowed or taken from the cash value of a life insurance policy is not subject to taxes up to the “cost basis” – the amount paid into the policy through premiums.
To understand how this works, take a hypothetical case of “Steve,” who bought a whole life policy in 1980. There are a couple of ways Steve could access his policy’s cash value during retirement. First, if he has a cash value cost basis in his policy of say, $132,840.00 (the sum of premiums paid), he could take a partial surrender of the cash value from his policy up to this amount and it would be income-tax free.
Secondly, Steve has the option to borrow against his cash value at any time and the amount borrowed will not be taxable as income, even if it is in excess of his cash value cost basis. Careful, though. A certain class of policies receive less favorable tax treatment than what is described above when taking loans and distributions and may be subject to a penalty tax.
It should be noted however, tapping into the cash value of a life insurance policy reduces its value and death benefit and increases the chance the policy will lapse. If a policy lapses with an outstanding loan in excess of the cost basis, it’s taxable.
Again, if you are thinking of taking a distribution it’s worth checking in with a financial professional about your particular policy and needs.
Provided by Kyle Lum, courtesy of Massachusetts Mutual Life Insurance Company (MassMutual) © 2016 Massachusetts Mutual Life Insurance Company, Springfield, MA 01111-0001 For more information, please see https://www.massmutual.com/individuals/educational-articles/index
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