One of the primary benefits of a life insurance policy is that life insurance proceeds aren't taxable - most of the time. In nearly all cases, you can purchase a life insurance policy and feel secure in knowing that your beneficiary won't have to pay taxes on the eventual payout. However, there are a few instances where a life insurance policy can serve as a tax shelter and some cases where you may be subject to some tax payments.
Who is Your Life Insurance Policy Beneficiary? Many people worry about whether their heirs will have to pay taxes on life insurance policy proceeds, this is a common concern. Yet, if your policy beneficiary is your spouse, you have nothing to worry about. Spouses are able to transfer wealth to each other free of taxes. However, if you've named children or anyone else as beneficiaries on your life insurance policy, taxes may be an issue under certain conditions.
According to IRS Reports, approximately 2 percent of U.S. deaths are subject to an estate tax. If the value of your policy and other transferred assets exceeds the state or federal estate tax exemption, then the policy would be taxed. Even in these cases, life insurance policy proceeds are often used to pay those estate taxes, which can reach in the hundreds of thousands of dollars.
Are You Maxed Out on Retirement Savings? If you have maxed out your IRA and 401k contributions for the year, you might have a tax problem. Finding additional investments for retirement that can produce income and provide tax advantages can be a challenge. One solution is the Indexed Universal Life (UIL) insurance policy that offers some fantastic tax benefits.
The cash value on the UIL policy achieves investment returns that are tied to the market, with minimum return guarantees. Also, you are able to take tax-free distributions of accumulated cash value, can exchange your policy without triggering taxes, and the death benefit passes on to loved ones tax-free.
When Life Insurance Proceeds Might be Taxed There are a few instances where life insurance proceeds could be subject to taxes, aside from the estate tax scenario already mentioned. Let's assume that you have a permanent life insurance policy and have taken out a tax-free loan from your built up cash value. If you decide to cancel that policy without repaying the loan, you'll likely owe some taxes. Also, if you sell or cancel your policy and the surrendered value is greater than what you paid in, due to investment returns, you might have a tax bill. Finally, if your beneficiaries elect to receive their payout over time with interest instead of as a lump sum, the interest paid by the insurance company will be subject to taxes.
If you own a business and have considered taking out key man insurance or any other form of employer-owned life insurance, it's also likely that the benefits from those policies will be taxed. A Congressional rule was put in place that applies to policies issued after Aug. 17, 2006. This new rule requires certain notices and consents to be signed before a life insurance policy is issued. Otherwise, the proceeds paid on the life insurance policy will be taxed.
Not only is a life insurance policy important to safeguard your family's financial future, but its tax benefits make it an attractive investment. In most cases, life insurance payouts, dividends, and cash value accumulation are not subject to income taxes. Contact us to learn more about our life insurance products or to request a quote now.