As you plan your estate, you want to know your beneficiaries won’t be saddled with a big tax bill along with their inheritance. Purchasing life insurance can help you avoid those penalties that come with money passed down through other means.
You can purchase whole life insurance, which will stay in force for your entire life as long as you remain current on the payments, or you can buy term life insurance, which covers only a particular term of your life with fixed payments.
Most tax benefits come with whole policies, though the last one listed below applies to term life insurance as well. Here are three ways life insurance can decrease tax liabilities.
1. Whole Life Builds Continual Value Without Any Tax Payments
When you make your monthly premium payment, you add to the money you save that isn’t subject to tax payments. That’s not so with retirement accounts, where you will pay now or later.
2. Take Payment From the Policy on Cash Value Using a Tax-Advantage Basis
The amount you pay on premiums into your life insurance policy can’t be taxed up to the cost basis. You can borrow from that money during retirement, getting access to the cash value without having to pay taxes. You can choose a cash surrender of the policy amounting to the premiums you have paid on it, and this will not be taxable.
Of course, the death benefit will decrease if you choose to do this, leaving less money for your beneficiaries. Also keep in mind:
You increase the likelihood the policy will lapse when you take out cash value
And if you take out more than the cost basis and the policy lapses, the amount you borrowed will become taxable
Clearly there is risk to this strategy. But by consulting with a professional, you can determine whether the rewards outweigh the potential pitfalls and how to move forward with this approach by mitigating your risk.
3. Death Benefits Are Usually Tax Free
Life insurance payouts can be very big, especially whole life insurance policies. In many cases, they are not subject to federal or state taxes, while most retirement plan proceeds that pass on to beneficiaries are. Putting money toward life insurance can save your beneficiaries money in the long run.
Keep in mind that your beneficiaries will have to pay taxes on any interest received from a life insurance death benefit, such as when it is held for a time after the policyholder’s passing.
Another case where death benefits may result in taxes owed? If the policyholder names an estate rather than an individual as the beneficiary.
Interested in learning more about the tax benefits of life insurance policies? Get in touch with Jay to discuss your financial future today. He can answer your questions about life insurance benefits and discuss other ways to avoid a high tax burden on those you love. Contact Jay today.