Do You Know These Tax Benefits of Life Insurance?

When you buy life insurance, you’re buying protection for your loved ones in case you’re not around to help support them financially anymore. That’s the main benefit of life insurance, but there are life insurance tax benefits, too.

The benefits grow along with your policy. There aren’t any tax benefits when you’re paying your premiums — you may wonder if whole or term life insurance is tax deductible. The premiums are considered personal expenses, so there’s no deduction. The benefits come later. 

Here are a few things to know about the tax advantages of whole life insurance.

1. Your Beneficiaries Probably Won’t Pay Taxes on the Benefit

Are life insurance benefits taxable? Usually, no. 

That can make a big difference for your family. Your life insurance payout is probably a lot of money — you may have $1 million or more in life insurance coverage. Paying taxes on that amount could cost tens or even hundreds of thousands of dollars.

There are some cases where federal or state taxes could apply, especially if you have a large estate. Your tax advisor can help you review your situation and decide the best course of action to minimize your taxes and leave as much money as possible to your loved ones.

1. Taxes Are Deferred as the Cash Value of Your Life Insurance Grows

When you pay your whole life insurance premiums, the cash value of your insurance grows. That money isn’t taxed at the time, so you have more money growing for you; you’re earning interest on a higher amount. 

You’re probably in your prime working years when you’re paying your premiums and the cash value of your policy is growing. If you decide later in life to cash out your whole life insurance policy, odds are better that you’ll be in a lower tax bracket. That means you’ll pay less in taxes if you have to pay.

1. The Cash Value of Your Policy Has Tax Advantages

The portion of the cash value of your life insurance that comes from the premiums you paid, called the cost basis, is generally not taxed. So, if you remove that amount or less from your policy, you shouldn’t have to pay federal income taxes. 

Of course, tapping into the cash value of your life insurance policy reduces its death benefit, so your heirs would get less money. If you’re thinking about taking money out of your policy, it’s a good idea to talk to your financial advisor and tax advisor and weigh all your options.

1. Life Insurance May Lower Your Taxes in Retirement

You may be wondering how to use life insurance to retire tax-free. As mentioned, you can withdraw up to the amount you have paid in premiums without paying taxes. Amounts you withdraw above what you have paid in premiums would be taxed.

You can also borrow money from your life insurance policy instead of withdrawing it. You can access a lot more funds when you borrow compared to withdrawing what you paid in premiums. Most policies allow you to take out a loan of 80% to 90% of the value of the account. You don’t pay taxes on this amount, but you pay interest. And, if you don’t repay the loan, it will be paid out of your policy after your death, so your family will receive less money.

Get the Most From Your Life Insurance

Life insurance is important, and choosing the right option for you and your family may be complicated, especially when there are tax issues to consider. A Farm Bureau financial advisor can review your investments and income streams, talk to you about your goals and help you create a plan for success. Reach out today.