Your relationship to life insurance can take a lot of twists and turns over the years. When you are young, life insurance may feel like a waste of money, and oftentimes you’ll only buy it because it is included in some sort of corporate employment benefit program. As you head into middle age and have a family and a home of your own it becomes a nice bit of peace of mind, letting you sleep at night with the knowledge that if you were in some sort of devastating accident your family would not be left high and dry. And as you enter your twilight years, life insurance becomes that thing you’d rather not talk about, as it means the inevitable end is coming, so you leave it to your kids and grandkids to worry over. But at each of those points life insurance can bring with it some serious tax advantages. In fact, if you play your cards right, carrying life insurance will trim your tax bill both while you are alive and after you pass away. Here is a quick look at some of the tax advantages of life insurance.
The first thing you must decide on is which type of life insurance you will purchase. Term insurance is fairly standard insurance coverage. If you die while the coverage is in place, your beneficiaries receive a payout. But if you let the policy expire while you are still alive, there is no remaining value. If you buy whole or universal life insurance, the policy carries a permanent cash value. The goal with permanent life insurance is to pay for death benefit protection and keep the premium payments consistent. The cash value you accrue will be available to your beneficiaries after death, but can also be drawn from the policy by the policyholder through various loan options. Most of the tax advantages will come along with permanent life insurance, so focus on those options to maximize your benefits and savings.
So what tax advantages will occur? Life insurance in a unique product that impacts your taxes like no other financial investment there is. The first benefit is that you won’t have to pay any income tax whatsoever on interest that accrues on the cash value of your policy. The longer you pay into your life insurance, the greater its value will be. But that interest will never be taxed. In addition, if you end up having to borrow cash from your insurance policy you will not pay income tax on that borrowed money either. The loans you take out would be treated as debts. Therefore you will always have a pipeline of money to draw from, without having to worry about how that will impact your yearly tax bill.
This can be very important as you enter retirement. You will have the option of continuously borrowing against your life insurance, and you never have to pay these loans back. In the vast majority of cases you’ll never pay any income tax, even if the money you pull from the account is strictly from the accrued interest. Just keep in mind that the lender you use to draw funds from your life insurance policy will probably charge interest on that loan, and depending on the size of the loan you could end up reducing the overall value of your life insurance policy. In addition, you will face income taxes if you fall below a particular ratio of cash value to death benefits. Make sure you talk it all over with your accountant before moving forward.
What may be the most important tax benefit, however, is that your beneficiaries will not have their proceeds from your insurance policy taxed as income. Whatever the dollar value of your policy, that is the dollar value of benefits that will be delivered. In addition, a savvy accountant will be able to structure your insurance policy in such a way that it doesn’t trigger estate taxes upon your death. This is tricky however, and not something you can handle through some accounting website. Work with a qualified financial planner and consult your attorney to make sure your beneficiaries receive maximum value.