The Tax Advantages Of Owning Life Insurance

Life Insurance is 100% tax-free. No federal, state or local taxes are due on your life insurance proceeds. You life insurance check will be sent to you in one lump sum, often within two weeks.
In addition to life insurance proceeds providing a financial cushion to loved ones who are left behind, there are also several advantageous tax benefits that go along with owning certain types of life insurance policy. In fact, life insurance policies hold a unique tax-advantaged status among financial products.

How Interest On Life Insurance Cash Value Is Handled

One of the biggest tax-related benefits to owning permanent life insurance is there is no income tax due on interest or other earnings that accumulate in the cash value component of a permanent life insurance policy. Your funds will accrue on a tax-deferred basis.

There are also no tax consequences if you take a loan from the balance of your policy’s cash value component. These loans are treated as if they were debts – and they are therefore not considered to be taxable distributions from the cash accumulation of the policy.

NOTE: A loan is not taxable. A withdrawal is taxable.

An additional benefit that is highly attractive is that life insurance policy loans are not required to be repaid. The only consequence is that if the insured passes away with any amount of unpaid loan still left on the policy, that amount will simply be deducted against the total amount of death benefit proceeds received by the insured’s beneficiary(s).

is life insurance taxable

Tax Treatment Of Death Benefit Proceeds

In addition to the advantageous tax treatment of a life insurance policy’s cash value, death benefit proceeds are also received free of income taxation by the policy’s beneficiary. This can be quite beneficial to the insured’s survivors, as they will know exactly how much money will be received to pay off debts of the decedent and other financial obligations that have been earmarked for these funds.

Therefore, when determining how much a beneficiary will need, and barring any unforeseen circumstances, a policy with a face amount of $100,000 will pay out $100,000 to the named beneficiary of the policy.

Life insurance is one of the last remaining tax-free vehicles remaining.

Life Insurance And Estate Taxes

There is another important area in which life insurance can provide tax benefits. This is the payment, reduction, or avoidance of estate taxes. In many ways, life insurance plays an active role in the estate planning process – primarily for its fabulous tax advantages. However, for this process to work as intended, the life insurance plan must be properly structured.

estate taxesIn doing so, it is important to note that even though life insurance policy proceeds are received income tax free by the beneficiary, these proceeds could be subject to possible estate taxation. Therefore, it is essential to structure the policy in the correct manner.

The U.S. system of estate taxation can potentially impose a tax on the transfer of a decedent’s taxable estate upon death. This tax is typically imposed – regardless of whether the decedent’s assets are transferred through a will, via their state’s laws of intestacy, or otherwise.

Due to such taxes, a decedent’s estate could potentially owe huge taxes on a large portion of the value of his or her estate. Often, these taxes could eat up over 50% of the value of the estate. Plus, these estate taxes are due in cash within nine months of the passing of the insured. Not too many people have 50% of a large estate in liquid investments. This often creates a nightmare financial scenario leading to a fire sale of assets resulting in selling at discounted prices. The problem is the IRS doesn’t care what you sold the asset for they only care about what the asset was worth at time of death.

life insurance and taxes

Imagine owning a $10M building at the time of your passing. You will owe approximately $5M in taxes on the $10M valuation.

Trouble is, imagine if the real estate market is weak, and you only receive a quick purchase offer for $6M.

With your estate taxes due in nine months your family cannot afford to wait until the market turns upward. Your estate sells the building for $6M. They then send the IRS $5M and have only $1M remaining.

A $10M asset is now worth only $1M to the living family members.

This scenario occurs very often and is 100% preventable with a simple life insurance policy.

The proceeds from a life insurance policy will pay the IRS the $5M and allow the heirs to retain the $10M office building.

I hope this example help you recognize the tremendous leverage benefits of purchasing tax-free life insurance to resolve your pending estate taxes.

Therefore, when estate taxes are a potential concern, a life insurance policy may be put in place for paying such taxes.

When doing so, however, it is important that the insured is not be the owner of the life insurance policy. This is because if the insured is also the policy owner, the value of the life insurance proceeds could then be included in the estate’s value – and potentially be subject to additional estate taxation.

There is, however, a solution. By moving ownership of the life insurance policy out of the insured’s ownership and into the ownership of a trust, for instance, the value of the policy’s proceeds will not be included in the insured’s total estate – and he or she will therefore not owe taxes on this amount.

Another solution is to have the adult children of the insured – if applicable – act as both owners and beneficiaries of the life insurance policy. By setting it up in this manner, the adult children could essentially “loan” the life insurance proceeds to the decedent’s estate to provide the funds that are needed to pay the estate taxes.

Purchasing Affordable Life Insurance Coverage

A life insurance policy can be a smart and easy way to enjoy additional tax advantages. Regardless of why you’re getting life insurance coverage, it’s important that you get a quality insurance plan at an affordable rate.

First, if you currently, or have in the last 12 months used any tobacco you’re going to have to let the insurance carrier know about it. A tobacco designation will raise your rates about twice as much as you would normally pay. So, to keep your rates down in the future you’ll have to quit using tobacco for 12 months in a row.

Another way to save money is to improve your overall health. You can do this by sticking to a healthy diet and getting regular exercise. The effects of your efforts will be noticed on the medical exam. All of these suggestions are going to translate into lower premiums from the insurance company, which means more money saved or even purchasing a larger life insurance policy.

Honestly though, to ultimately find the plan that fits your needs the most you will probably have to get a rate from several life insurance carriers. Sound daunting? It could be, unless you work with us, an independent insurance agency. Being independent gives us access to dozens of leading carriers in the country and in-turn that leads to less work, less stress and lower premiums for you!

How Much Coverage Do You Need?

Before you apply for a plan, it’s vital that you determine how much insurance coverage that you’ll need. There are several different factors that you’ll need to consider ensuring that you’re getting enough protection for your loved ones.

The first number that you should crunch is outstanding debt that your family would be left with if you were to pass away. The first goal of your policy benefit is to give your loved ones the money that they need to pay bills without draining their bank account. Make sure that your plan is large enough to pay for those debts.

The next number to look at is your salary. If you’re a primary income earner in your home, your dependents could struggle to keep up after bills are paid. So, add in a few years of your salary to give them sufficient funds to allow time for your spouse to recover.

The Bottom Line On Life Insurance Benefits

In addition to paying out a tax-free benefit upon an insured’s death, life insurance policies can also be a primary component of one’s overall financial, retirement, and estate planning strategies.

Life insurance can help you and your loved ones to protect assets, maintain a quality lifestyle, follow through on financial promises, pay off final expenses and other pressing debt obligations, and attain substantial tax-related advantages.

The easy part of life insurance is deciding to buy one, but the hard part will be finding the rate and policy that fits your budget. That’s why our advisors love to help make sure everything goes smoothly for you and help you save money on your coverage. We hold our book of business up against anyone else’s and our list of companies provides a variety of plans and rates.

If you are still confused about the tax advantages life insurance offers, we can help you out. Just give us a call!

Perhaps your concern is something different such as qualifying for insurance with health conditions.  There are life insurance policies with no health exams so don’t let anything stop you from getting the coverage you deserve.

How To Use Life Insurance To Fund Estate Tax Liability

Unfortunately, throughout our lifetimes we are taxed on almost everything. When income is earned, it is taxed. When items are purchased, they are taxed. When investments are sold at a profit, the gains are taxed. When we pass away, our estate is taxed. This is what is known as the estate tax.

Estate taxes are defined as being the tax that is imposed on one’s heir’s inherited portion of their estate – provided that the value of the estate exceeds a certain amount. There are certain exceptions to this, however. For example, if an individual leaves everything to his or her spouse, then all assets will transfer to the spouse estate tax-free.

Unfortunately, when the second spouse dies, the beneficiaries who inherit the assets will then likely be hit with a substantial amount of estate taxes if the amount of assets exceeds the exclusion limit. In this case, it is highly recommended to have at least some amount of life insurance in place for your estate planning strategy.

Life insurance is the best safety net you can every purchase for your loved ones. It’s one of the few ways you can ensure your family will have the money they need should an unexpected tragedy occur to you. When you’re planning for the inevitable and securing your family’s financial future, there are numerous factors you need to consider ensuring your family will have the money they need if something tragic were to happen to you.

One question a lot of policyholders have about life insurance is regarding a pending large estate tax. It’s important you understand how taxes are going to impact your life insurance proceeds so your heirs can have enough remaining cash to retain their lifestyle.

How Life Insurance Can Help to Reduce Estate Taxes

Did You Know??
Estate taxes are based on the valuation of your estate at the time of death and are due to the IRS in nine months in cash.

Although people can never eliminate estate taxes, these taxes can at least be paid with life insurance proceeds at pennies on the dollar. Proper estate planning is the key. Without such a plan, you could be at risk of paying huge estate taxes to Uncle Sam directly from your estate. This will reduce dramatically what your heirs will receive.

Life insurance can be an important part of setting up a solid estate plan. This financial tool can provide a number of benefits to your estate, including estate liquidity for the payment of tax, wealth accumulation, income replacement for your survivors, and debt repayment options for any obligations that have been left unpaid.

How to Set Up Your Plan

When using life insurance to reduce estate taxes, it is essential that your plan be properly set up and implemented. Otherwise, you could end up with an even larger tax liability than you started out with. This is because if you retain ownership of the life insurance policy, the policy’s death benefit proceeds will be counted as assets in your estate and will therefore be included in the taxable amount, thus increasing your estate tax and not reducing it!

You will need to remove the life insurance policy from your ownership. One way to do so is to set up an irrevocable life insurance trust, or ILIT. By making the trust the owner of the life insurance policy, it will eliminate the risk of higher estate taxes being due. Specifically, the life insurance policy proceeds will not be counted as a part of your estate’s taxable assets.

When the ILIT is set up, you will begin to annually gift funds into the trust to pay the life insurance policy’s premium. One thing that you will need to do when creating an ILIT is choose a trustee. This is required because you are not allowed to serve as the trustee of your own ILIT. Therefore, it will be necessary to choose either another individual, or a corporate trustee.

At death, the life insurance tax-free death benefit proceeds will be paid to the trust, where the trust document will provide instructions on the use of those funds. This could include the ability to loan money to your estate, or even to pay an amount to your beneficiaries.

Because the death benefit of the life insurance policy will pass directly to your beneficiaries outside of your taxable estate, the money will essentially replace the wealth that will be lost to estate taxes. If you are needing final expense insurance rates, we can point you in the right direction.

Other Possible Uses for Irrevocable Life Insurance Trusts

ILITs can be used in situations other than estate planning. For example, young parents may create a life insurance trust to enhance the value of their estate should they pass away prematurely.

Because many younger parents have not accumulated a sizeable estate, the death benefit proceeds from the life insurance policy is often used for the care of their surviving family members if the primary wage earner is no longer alive.

Still, others may set up an ILIT to offset assets that are given to a charity. A typical situation may involve someone who makes either a direct gift to a charity or creates a charitable remainder trust. Because the charity receives the assets rather than family members at the time of the donor’s death, the ILIT is set up to benefit the family and to replace the assets.

Taking the Next Step

The setting up of an irrevocable life insurance trust can be somewhat complex. Therefore, it is important to work with a professional who is well versed in estate planning to ensure that your trust is set up correctly. Although this process does take some time, it is well worth the effort for the large amount of money that it can potentially save you and your loved ones in unnecessary estate taxation.

There are so many different factors you should consider as it can be an overwhelming and confusing process. It’s important you start taking those next steps as soon as possible.

Getting the Best Life Insurance

If you decide to go with a traditional insurance policy, there are a couple of things you can do to reduce your premiums. It’s important you get the most affordable life insurance out there.  One simple way you can lower your rates is to cut out any tobacco usage. If you’re a smoker, you should expect to get drastically more expensive rates. Smokers are going to pay at least twice as much for their insurance coverage compared to what a non-smoker is going to pay for the same sized policy.

Another way you can save money is to improve your overall health. When you apply for life insurance plan, the insurance company may require you take a medical exam. The results of the exam are going to impact how much you pay in premiums.  Of course, there are numerous no exam life insurance policies available to you as well.

Improving your health is one of the best ways to lower your rates and keep more money in your pockets. Two of the best ways to do this are to get exercise and stick to a healthy diet.

When you are searching for life insurance, there are many various factors you need to consider ensuring you’re getting the best plan for you and your loved ones. It can be a confusing process, but it’s why we are here to help.

Every insurance company is different, and all of them are going to give you different rates. It’s important you get several quotes before you decide which company is best for you.

Unlike a traditional insurance agency, we are insurance brokers. We don’t work with one single company, we represent dozens of the best rated companies across the nation. We can bring a personalized set of rates directly to you. We can save you time and frustration from having to telephone and work with several different agents.

Bottom Line

You never know what life’s going to throw at you today or tomorrow, which means you shouldn’t wait any longer to get the insurance coverage you and your loved ones deserve. Regardless of the kind of life insurance you’re buying, either a traditional plan or a trust, it’s important you have the proper plan in place.

If you have any questions about how your life insurance will impact estate taxes, or you want to explore some of the options available, please don’t hesitate to contact us today. We would love to answer those questions and give you the best plan for you and your loved ones. Our agents have years of experience working with all kinds of clients and companies.

About InsuranceScored.com
About InsuranceScored.com

Susan Wright, CLU, ChFC, RHU, REBC, ADPA, CITRMS, CIPA has been in the insurance and financial field for over 27 years. Even with years of experience, she continues to create new resources for others. Everything from books to training material.

Susan received her MBA from St. Louis University and her BA from Michigan State University.

She has worked in several areas but excels in writing material for both finances and insurance. Her goal is to give professionals credibility and assist in streamlining the sales process.

She has written countless articles for a variety of websites.

This entry was posted in Life Insurance. Bookmark the permalink.