When it comes to life insurance, there are many things to consider. One of the most important is taxation. What happens to the life insurance policy when the person who purchased it dies? What if they didn’t die? What are the tax implications for beneficiaries? In this blog post, we will discuss life insurance policies’ five main tax implications. By understanding these implications, you can make better decisions about your life insurance policy and its impact on your taxes.
Here Are The 5 Tax Implications of Life Insurance
Life insurance is a type of long-term savings that pays out a death benefit in the event of your death. You may consider life insurance income replacement protection for your family if you die. But what are the tax consequences of taking out life insurance? Here are some key facts to keep in mind.
Death benefits
Usually, life insurance payments made under a policy are not subject to income tax. There are, however, certain limitations. For example, if you sell a policy during your lifetime (a sale, for example), the money paid to your beneficiary may be taxable. A transfer to your corporation is an exception to this transfer-for-value rule.
Cash value
Some of your premiums go into an account that gets bigger over time with cash-value life insurance, like an assurance vie permanente policy. The money you save over your lifetime isn’t taxed. You can borrow money from the cash value without paying taxes unless you give up the approach.
One warning: If the premiums you pay for the first seven years exceed certain restrictions, your coverage becomes a modified endowment contract (MEC). Policy loans and withdrawals might be subject to tax under MEC rules.
Accrued interest
After the date of death, an insurance company may pay interest in addition to lump sums. The beneficiary is taxed on any interest paid after the date of death.
Exchange of policies
If you move one assurance vie policy to another, the transaction may be tax-free. When a current contract becomes outdated, and you want improved service or new features, you’ll usually do a “Section 1035” exchange. Keep in mind that a genuine dialogue must take place. You cannot pick up a check and use the money to purchase a new policy.
Estate tax on proceeds
Life insurance benefits are taxable under the federal estate tax if the insured possesses “incidents of ownership,” such as the ability to give up the policy. You can prevent this by transferring ownership rights to someone else or setting up a life insurance trust.
Is Life Insurance Taxable?
Assurance vie benefits you as a beneficiary receives aren’t taxable and don’t have to be reported. Any interest income you obtain is subject to taxation and must be recorded.
Do People Who Receive Life Insurance Benefits Pay Taxes On Them?
If the total amount of your assets is more than $11.7 million, your beneficiaries may be subject to federal estate taxes. If the state you live in charges an estate tax and the value of your estate exceeds the state’s threshold (ranging from $1 million to $7 million, depending on the state), they may also be subject to state tax. Even if your state does not charge taxes when someone dies, the beneficiaries may have to pay taxes if the state where they live has an inheritance tax.
