Life Insurance and Taxation – Know the Particulars
Life Insurance and Taxation Know the Particulars
Life insurance is advertised as being "generally" free from taxes. This means that the funds paid out from your policyeither the death benefit itself or cash value if you have a policy that this applies toare tax free in most situations. However, unless you take the right approach, certain kinds of taxes may apply depending on your situation. Here are some of the particulars you will be interested to know.
Estate taxes will not apply to the death benefit itself unless the insured possesses incidents of ownership. This is easily avoided. However, estate taxes are still of interest to life insurance policy holders because life insurance may be obtained in the first place to help offset estate taxes that heirs will be subject to when their parents die. If the benefactors receive a property or other non-monetary form of inheritance, there may be no funds with which to pay estate taxes. To avoid liquidating the inheritance for the sake of paying taxes, beneficiaries can use the funds paid out from the life insurance policy to cover these costs.
Income taxes are of interest in various areas of life insurance. First, the death benefit is not taxable income. Second, the cash value will only be subject to income tax if it exceeds the amount you have paid in premiums or if you borrow money from the cash value sum and your policy lapses before you pay the money back. Third, premium payments cannot be claimed as a tax deduction on your tax return. Fourth, dividends that you may earn because of the investments that part of your premium payments have put into are not taxed unless you earn more in dividends than your premium cost in the first place.
Capital gains taxes generally do not apply to life insurance policies, but sometimes a policy may be set up so the proceeds are considered capital gain instead of regular income. Situations in which capital gains taxes can be collected are the same as when income taxes can be collected.
Gift taxes may apply if someone other than the insured pays part of the premium costs. If this "gift" remains under $13,000 per recipient and donor, it remains tax-free.
In order for you to take advantage of the fact that life insurance is tax free in most situations, you will need to abide by certain guidelines set up by the federal government's tax code guidelines. Working with a knowledgeable agent will ensure this.
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