Home Insurance Book Is Insurance Money Taxable?

Is Insurance Money Taxable?

by insurancebook

To be sure how your policy will be treated as regards state and federal taxes it is best to check with a tax consultant or tax attorney.

Table Of Contents

If My Term Life Insurance Policy Gets Paid Out, Is The Money Taxable?

There are ways to determine how much life insurance you want to get in order to provide financial protection for your family should you die. You can get enough insurance to pay off all of your debts including your mortgage, plus a bit extra to buy time for your wife to enter the workforce.

You can add up how much money you would have made until you retired and get coverage up to that amount. You can work out what amount of money should be put in a savings account or CD to earn enough interest to equal your income and get that amount of coverage.

But what about the taxes on the money paid out from the insurance company? What taxes have to be taken into account when doing all of this planning?

Since we are talking about a term life policy there are no investment or cash value complications to consider. First you should know that the premium payments are generally not tax deductible.

And as a rule, as long as you name a beneficiary in the policy, the proceeds that are paid out upon your death are not taxed. If the insurance is part of your estate meaning you haven’t named a beneficiary or the beneficiary is your estate then proceeds are subject to estate tax and/or inheritance tax.

So the message here is to be sure to name a beneficiary for your policy to ensure the insurance money is paid directly to an individual and doesn’t go through you estate and the money won’t get taxed.

To be sure how your policy will be treated as regards state and federal taxes it is best to check with a tax consultant or tax attorney.

So generally speaking the methods of calculating how much life insurance you should buy do not take into account having to pay taxes on the money paid to your family.

Senior Citizens and Life Insurance: Is It Too Late?

Senior citizens often time think they are too old to get affordable life insurance. This is very much not the case. A person is never too old to try to protect their loved ones through the use of insurance.

Throughout our lives we try to save and build our estates so we can pass on wealth to our children. Often times in many cases life gets in the way of our plans and we don’t save nearly as much as we would have liked to. Many investments come with too much risk for a senior to be able to comfortably invest. So what is a person to do? That is where insurance comes in.

When a company sells you an insurance policy, they take your money and invest it. They hope that you live a long time and that their investments do well. If the investments don’t do so well then they lose out, not you. Your insurance is safe. Don’t you wish you could put even more money into your insurance and enjoy lower risk investments? Well you can.

Seniors can place their savings in an insurance policy purchased in a lump sum, and thus protect that money from loss and increase the principle upon your death for your beneficiary.

By purchasing an insurance policy on your life, you protect your money in a few different ways. First, you are protected against market loss because the insurance company has to pay you your death benefit no matter what. Next your money will pass on to your beneficiary’s automatically without probate or court proceedings. There is also absolutely no estate tax when your heirs get your money, insurance policy proceeds are non-taxable. Lastly insurance money is protected against debt collectors, and civil liabilities. That means that if you’re a senior who is ill and racking up medical expenses the money you placed in your insurance policy can not be touched by the hospital or any other creditors.

There is no other investment that can offer such amazing benefits as an insurance policy, and because of these life policy perks it makes for the ideal investment for senior citizens. Not only can they protect the assets they wish to pass on to their loved ones, they can also increase the value of that money through insurance. Even better, they could still withdraw the money from the policy if they really needed to with no penalties or fee’s. They don’t even have to pay the money back, it just gets deducted from the death benefit.

So as you can see, it is never too late to look into insurance options and in fact we all should.

Do You Tax Life Insurance?

Many people wonder if it’s possible for the government to tax life insurance. The basic answer to this is “no”, they cannot tax life insurance (although you can rest assured that the Congress tries to enact legislation that would allow it every year). However, it’s possible that money you get from your life insurance policy could lead into a taxable event.

Typically, if you receive a death benefit payment from a life insurance policy, that money comes to you tax-free. Every cent of it is yours and yours alone. Furthermore, if you have a cash-value-building life insurance policy like a Universal Life or a Whole Life policy, the money that accumulates inside that policy is all tax-sheltered.

However, there are some loopholes in these regulations that allow the government to dip its hand into your pocket when it comes to life insurance.

Cash-building life insurance policies have the possibility of eventually pushing up the ceiling on the death benefit, so that the death benefit when paid out is more than the face amount of the policy.

If this happens, then all of the death benefit proceeds that you receive over and above the original face amount is considered taxable income when you receive it and must be reported.

So, let’s say that someone had named you the beneficiary on a Variable Universal Life Policy that they took out for a face amount–the original death benefit amount–of $1,000,000. They have the policy for 30 years and they do quite well with the investment side of the policy, so that when they die you are paid $1.4 million.

You must report the $400,000 on your income tax, but not the $1 million. The $400,000 is considered a withdrawal from the policy (the ultimate withdrawal!), and it’s possible for policy withdrawals (which of course can also be made by the insured while he’s still alive) to become taxable events. (But see below about how withdrawals are taxable.)

With cash-building life insurance policies, you never have to pay taxes on insurance company dividends given to you, for they are legally considered a return on premiums, and premiums are tax free.

However, if you receive interest on your dividends, you do have to report them for tax purposes.

If you take a withdrawal from your cash-building life insurance policy, if you exceed the total amount of premiums you have put in to that point, you have a taxable event on the amount you take out that is in excess of premiums.

So, if you have paid $5,000 of premiums into a life insurance policy then take out $6,000 when there’s enough cash there for you to do so, you must report $1,000 on your income tax for the year that you took the money out. However, there is a way around this by taking advantage of life insurance companies’ loan-against-policy privileges. You’ll have to pay the money back with a very low interest rate, but this keeps you from being taxed.

With VUL insurance, you have actual investments inside the policy. These accumulate their money tax-sheltered. When money comes out of the policy and it’s not a loan, you have a possible taxable event. But, there’s more good news here: this taxation is done on a FIFO basis (first in, first out), meaning that you are considered to be taking out your input first.

Whatever you put into the policy cannot be taxed (usually), only your gains can be. So this minimizes your taxable event. VUL policies are used more and more by financial planners to help their clients accumulate money for retirement while minimizing their taxes by capitalizing on the limited ability of the government to tax life insurance.

You may also like

Leave a Comment

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More