This question is for sure one of the first that come to anyone’s mind. So, is life insurance taxable? Well, it all depends on how you see life insurance and what role it plays in your life. If you own life insurance strictly for its death benefit, then no it is not taxable. However, if you purchased a policy for its lifetime of benefits, then yes, certain components are taxable. In most cases policy premiums are paid with after tax dollars. This means any money that comes out of a policy should be tax free.
Is the Benefit From Term Life Insurance Taxable?
This one is a pretty straight forward answer. You make money. You pay income tax at the end of the year. Money for premiums come from whatever you kept. Term life insurance is a straight death benefit only policy type. Hence, the death benefit paid out to a beneficiary is not subject to form of tax. If the beneficiary puts this money into an interest bearing account, than that interest does become subject to regular taxes.
The Tax Rules on Whole Life Insurance
This is where the question of taxability gets a little more complex. Reason is that whole life policies are cash bearing. They offer a death benefit just like term policies. For tax purposes the whole life’s death benefit is classified the same way as well. Even if the death benefit is increased through paid up additions, it is still income tax free. We already discussed the tremendous power of paid-up additions on our site.
After a few years, your policy will start generating cash value. This aspect is considered a yield from your policy. It is available to you at anytime. If you decide to withdraw the cash value, then just like any other income, this part of your life insurance is taxable. This is why it is recommended you take this money out as a loan, which you may repay at your convenience.
Cash value policy loan
We will devote a separate article to policy loans as it is a pretty complex topic. But from the tax perspective, cash value loans are an option to avoid paying income tax. Of course every loan comes with interest. And since you are paying interest, then you do not have to pay income tax. Whole life loans are interesting because on one hand you are borrowing your own money, but on the other your policy provider still pays you dividends for the entire cash value as if the entire amount was still in your policy. This way you are borrowing your own money, and instead of paying full interest, you only pay the difference between the two percentages.
Take Full Advantage of Life Insurance Benefits
We hope this article helped you better understand the tax aspects of policy benefits. If you want to start a more personal conversation, then simply fill out this form and we’ll get back to you shortly with specific numbers. Looking forward to working with you to help you achieve your financial objectives.