Tax Implications of Life Insurance

One of the most vital parts of financial planning is life insurance. It is essential for people of a higher age as it helps them ensure their loved ones are in good care once they die. Life insurance, however, comes with necessary tax implications one needs to consider when selecting the beneficiaries. 

There is a series of information one needs to manage, which ranges from payout taxes to estate taxes.

Taxes on Life Insurance Payouts 

The lump sum of life insurance proceeds will not have income taxes. Subscribers to life insurance premiums pay for it using a series of premiums. The death of the policyholder triggers the release of the lump sum to the beneficiary. Paying and disbursing life insurance this way does not make the benefits taxable, except it comes with income taxes. 

People who prefer permanent life insurance and not term life insurance might not have to deal with taxes, while the policy will have a lot of cash value. Policies paying dividends will not be subjected to tax except you get above what you paid as a premium.

As evident, there are a series of ways one can get gains tax-free from the life insurance policy. Also, some life insurance decisions can cause taxation of some or the entire life insurance policy. 

The following explains some cases when life insurance becomes taxable:

Taxes paid on Installment Payments of Life Insurance. 

There are life insurance beneficiaries and policyholders that form their policy such that the proceeds go to the beneficiary monthly or annually, rather than having a lump sum. 

This strategy makes the bulk of the policy generate interest overtime in which the interest will be classified as taxable income. This also applies to an interest in which the death benefit came between the policy owner's death and when the funds got to the beneficiary.

Estate Taxes and Life Insurance 

One might need to pay estate taxes on death benefits that come from life insurance. This often is a factor of how large the policyholder’s insurance policy is, alongside other assets. An approach to remove your life insurance policy from the taxable estate after death is to name one's spouse as the beneficiary. Policies (life insurance) left to the spouse are not classified as part of the deceased's estate.

There is also the option to name the beneficiary as the policy owner. This beneficiary might be the spouse or a relative. However, this ownership transfer needs to have been affected at least three years before death to avoid taxation. 

Surrendering Your Life Insurance Policy 

Let's assume you have been making monthly premium payments using a universal life insurance policy. The paid premiums cannot be said to be the same as the policy's cash value. You might decide you want to withdraw from the policy if you withdraw any amount above what you paid as premiums will be taxable. 

In surrendering the policy, the difference between the value and the amount paid as a premium is the taxable income. To avoid the tax implications of withdrawing, the policyholder should get a loan from their policy and not make a withdrawal. This allows them to have access to their insurance policy. 

Conclusion 

If you manage your life insurance policy well, you can significantly reduce what you send to Uncle Sam. Life insurance and taxes have a general rule that taking money in excess than you paid to the policy will result in more taxes. This applies to the interest that comes from your policy and the funds you withdraw yourself via a surrender.

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