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Originally Posted On: https://jennifer-lang.insurancedivision.com/28155/O5Ubc9/7-tax-tips-for-life-insurance

It’s tax time once again…and life insurance is probably the last thing on your mind. But did you know that your life insurance policy can affect your taxes?

Here’s what you need to know.

1. You Can’t Deduct Your Premium Payments

Although the IRS allows some insurance deductions (such as health insurance for the self-employed), life insurance doesn’t fall under that umbrella. Life insurance is considered an elective purchase, not a necessary one, so it’s not something you can deduct.

2. You Might Be Taxed if You Bought with Pre-Tax Dollars

Some employers include life insurance as part of their qualified plan benefits. If this is the case, you have the option to use pre-tax dollars to buy life insurance, just like you use pre-tax dollars to pay into your 401(k). If you bought your policy this way, you may owe income tax on the economic value of that life insurance (not the cash value, if there is any). Ask your financial advisor or your company’s benefits specialist if this particular tax situation applies to you.

3. You Might Be Taxed for an Employer-Sponsored Policy

Many employers provide a small life insurance policy as part of their benefits package—often, these policies are small, with a face value of less than $20,000. But if your employer pays for a policy that’s worth more than $50,000, for example, you’ll be liable for income tax on the portion of the policy that exceeds $50,000.

4. You Don’t Owe Tax on a Lump-Sum Death Benefit

In almost all cases, you won’t owe income tax on a death benefit you received. It doesn’t matter how big that death benefit was, who bought it, or how they paid for it. You, the beneficiary, won’t owe any income tax if you take it in a lump-sum payment. If, however, you choose to take the death benefit in installments, you might owe income tax on any interest generated by the unclaimed portion of the death benefit.

5. You Don’t Owe Tax on Your Policy’s Cash Value

If you have a cash value policy, a part of every premium payment you make goes into your cash value account. That money earns interest over time. You might be surprised how much cash value can accumulate in a policy you’ve had for 10 or 20 years! No matter how much cash value your policy has, you don’t owe any tax as long as you leave that cash value where it is. Of course, if you want to access it, you can use policy withdrawals or loans. Those situations each have their own rules for income tax, discussed below. But if you’re accumulating cash value without accessing it, you won’t owe a dime of income tax on it.

6. You Don’t Owe Tax on a Cash Value Policy Loan

If you own a cash value policy, you can take out a policy loan to access that cash value. The good news is you won’t owe income tax on the amount you were loaned (except for a policy structured as a MEC). Even if you take out more money than the sum total of premiums you’ve paid, you won’t owe tax on that loan money…as long as you keep your policy in force.

7. You Might Owe Tax on a Cash Value Withdrawal

You’re allowed to withdraw as much cash value as you like up to the sum total of your current premiums paid, all without paying income tax. (Note: If you’ve already taken withdrawals or dividends from your policy, subtract that amount from your total premium payments to see how much you can still withdraw, tax-free.) If you withdraw more than that amount, you’ll owe income tax on the portion that’s over your total premiums paid.

Life insurance is a wonderful financial tool, but it does take a little guidance from a professional to get it set up correctly. If you need guidance or clarification, I’m happy to help.

In addition to the potential tax benefits, there are plenty of other good reasons to buy a policy. The most important is financial security and peace of mind it gives your loved ones.