Basically, taxes have to be paid at some point. So, as long as you are making the premium payments, your beneficiaries shouldn’t have to pay taxes on their funds.
However, if your life insurance policy is part of a compensation package from your employer, your beneficiaries may need to pay taxes on the funds they receive. This is because your employer may write off the premium payments they provide on their taxes, which means the taxes aren’t paid.
4. What is taxable gain on life insurance?
The taxable gain is the dollar amount you receive from the cash value of your policy, minus the premium payment(s) you paid into your life insurance policy. This only applies to life insurance policies that generate a cash value, and are surrendered before the death of the person whose life is being insured.
An example might help!
Let’s say you have a whole life insurance policy with Auto-Owners (of course). If you decide to “cash out” or “surrender” your policy early, you will receive the cash value of your policy.
So, let’s say you paid $15,000 in premium payments on your policy so far. During this time, your policy accumulated a $20,000 cash value. So, that $5,000 difference is considered your gain and is therefore taxable because of the interest that accrued on your policy.
Now, before you get any ideas, please remember the goal of life insurance is to provide financial help after the loss of a loved one. It is not an investment strategy.
5. Do you have to pay taxes when cashing in a life insurance policy?
This is an emphatic yes!
Remember, the goal of life insurance is to provide financial help after the loss of a loved one. It is not an investment strategy. This is why the federal government taxes the gains when an individual cashes in the life insurance policy.
When you “cash in” a life insurance policy with a cash value, you are taxed on the gains. Your taxable gain is the dollar amount you receive from the cash value of your policy, minus the premium payment(s) you paid (read question four for a detailed example).
Each situation will be different, but expect taxes.
Overall, it’s a good idea to talk with your financial consultant/tax adviser/independent insurance agent/attorney/CPA/accountant. It’s worth the time, and your peace of mind.