Many a times, taxes and insurance claims coincide. While many people misunderstand why their life insurance is taxable, others do not know when it should be taxed. This article addresses both categories of people and explores the circumstances under which life insurance can be taxable.
Is life insurance taxable?
The money paid for life insurance claims is called a payout, which is not legally taxable. In the eyes of the law, it is not recognized as a taxable income. Nevertheless, under certain circumstances, proceeds from your life insurance are taxable; that is when they take the form of cash value. The cash value is the interest that grows over time with the insurance policy, which may be taxable depending on how it is employed in your whole life policy.
Is the cash value from an insurance policy taxable?
The cash value is taxable when gains are made. By gains, we mean when you make more than you put into your insurance policy. To arrive at the gain, you subtract what you take out of your insurance policy from premiums paid. The odds are high that there will be no gains if your life insurance policy has been active for a long time. A term life insurance policy doesn’t allow for any form of withdrawal. This means gains don’t stand in a life insurance policy.
The case is different for the cash value of a whole life policy. In a whole life policy, the cash value can be withdrawn as a loan with interest. Loans taken when your insurance is active are not taxable. When the loan exceeds your whole life policy coverage, the proceeds become taxable.
Conditions that make your life insurance taxable.
Your life insurance becomes taxable when it involves more than one person. The policy owner, the insured, and the beneficiary are three different people. The policy owner owns the insurance and pays the premium, the insured is the person whose death makes claims credible, and the beneficiary is the person who receives the payout. As a policy owner, you must choose a beneficiary in the event of your demise before the insured. This secures the life insurance policy.
What is taxable in a whole life assurance policy?
A whole life assurance policy is more complex than life insurance. You’re better off projecting for the tax implications versus your payout and cash value as time passes. Updating your insurance details and having updated and multiple beneficiaries would reduce the odds of your money being subject to taxes. Your estate, partial withdrawal, and accelerated benefit rider are not taxable.
Your modified endowment contracts (MEC) are taxable. An MEC is when you have made excessive payments to your whole life policy in the first seven years. In light of this information, the IRS considers your policy as an investment. When dividends from your life insurance accumulate in your policy, interest accrues. This means your life insurance becomes taxable.
Life insurance is taxable when dividends accrue or when there is a MEC in your policy. Outside this, the odds are low that your life insurance would incur tax. Do you have additional questions about your life insurance coverage? If so, then contact the experts at Randy Jones Insurance Services in Pleasanton, California. Our dedicated team is eager to assist you with all your personal insurance needs today.
