Life Insurance and Taxes

Robert Taurosa, Life Insurance, Benjamin FranklinUnfortunately for many, the tax deadline is approaching. Full of complexity and difficult-to-read text, tax season has innumerable individuals banging their heads against the wall in frustration. It brings with it added work; but hopefully it brings with it a positive return as well. You may be asking yourself how tax season pertains to your life insurance policy and whether or not your coverage can impact your return. Well, it can and oftentimes does. However, it depends on a couple key fundamentals:

Who bought the coverage?

Whoever put forth the funds to attain a policy now holds a valuable asset with respect to federal law. The intriguing caveat to this is that whoever made the purchase may not have to pay state or federal taxes on the asset’s possible cash value increases.  Also, the beneficiary of your policy may be able to receive the full death benefit free of taxes. The government is less inclined to tax income gained through insurance since the primary purpose of a policy is to safeguard loved ones in the event of an accident. This said, should you surrender your policy (forfeit it for cash) and you receive more money than you initially paid into the coverage, you will be taxed for the difference.

What benefits are involved?

The recipient of your death benefit will generally receive the funds tax-free for reasons stated above, so long as said benefit is paid directly to the recipient. If the recipient is a minor for instance, there may be some complications. Regardless, the form of payment itself is irrelevant. Ideally, the benefit should be tax free whether or not it is paid out in installments or all in one comprehensive sum. It should be noted however, that any “interest generated-above and beyond the death benefit” can be taxed and is required to be reported to the authorities.

There is something known as “living benefits” as well. These generally come in conjunction with whole life plans and are accessible through certain circumstances. Generally, those circumstances are confined to specified medical conditions. The good news is that these “living benefits” should be tax-free in the vast majority of cases. Additionally, it is worth mentioning that in the event you access these sorts of benefits, you will be reducing the overall cash value of your permanent plan.

This is not to forget what is known as a policy loan. In many cases, an individual can take out a loan using the cash value of their life insurance plan as collateral. A useful tool, this sort of loan is tax-free and is utilized by many for a myriad of reasons, not the least of which being to help fund college or perhaps to support an emerging commercial enterprise.

This all said, there are many complicated intricacies characterizing the tax guidelines surrounding life insurance policies. With 50 different states and 50 different sets of tax guidelines, there is no concrete universal tax rule that can be applied to every unique plan that is out there. While this article can serve as a foundation for basic tax understanding as it relates to life insurance, you are best served speaking to an accountant or qualified professional. Regardless, let your plan work for you as it relates to taxes, not against you. Good luck!