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Is the cash value of a life insurance policy taxable?

Chelsey Tucker graduated with a Bachelor of History degree from Metropolitan State University in 2019. She now writes about insurance with her specialty being life insurance and has been quoted...

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Dan Walker graduated with a BS in Administrative Management in 2005 and has been working in his family’s insurance agency, FCI Agency, for 15 years. He is licensed as an agent to write property and casualty insurance, including home, auto, umbrella...

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UPDATED: Mar 19, 2020

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Life Insurance Cash Value TaxesIs life insurance cash value taxable? Life insurance policies that earn cash value have several benefits over life insurance policies that do not earn cash value. One of the biggest benefits is the tax advantage that comes with your cash value life insurance policy.

Provided the cash value is less than what you have paid into your life insurance policy overall, the cash value is not taxable.

Read on to learn about the taxability of cash value in life insurance policies of various types and then to find the very best life insurance be sure to enter your zip above for free insurance quotes!

Different Types of Life Insurance Policies

There are different types of life insurance policies that you can buy and each has its own set of pros and cons. Traditional life insurance, also known as whole life insurance and universal life insurance, is a lifelong insurance policy. These policies are purchased with true life insurance in mind.

Provided the premiums are always paid on time, these policies last a lifetime, paying out benefits to the insurer’s beneficiaries at the time the insured passes away. In addition to having life insurance for your whole life, these policies earn cash value on them, giving you additional benefits. The con to whole life insurance is the cost of it in comparison to term life insurance.

Term life insurance is life insurance that is only purchased for a set amount of time. For example, if you purchase term life insurance for a 20 year term, then you only have that life insurance policy in effect for 20 years from the date of purchase. Term life is less expensive than whole life insurance, which makes it appealing to many people. However, unless the insured dies during the term purchased no benefits will ever be paid out.

How Life Insurance Policies Earn Cash Value

Whole life insurance policies build cash value over the life of the policy. The cash value that gets built earns interest every month and can be used as payment toward the monthly life insurance premium that is due. Depending on the current market, your life insurance policy can pay dividends, although it is not guaranteed. The cash value that is earned can accumulate and be used for different needs in the future, such as for the purchase of a new home or for education for your child.

Variable whole life insurance policies also earn cash value, but instead of using the credit to apply toward premiums, you can divide the interest into several accounts similar to mutual funds. While there is no guarantee on the growth of investment funds, most variable whole life insurance policies offer several choices, from low risk funds to highly aggressive funds.

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The Tax Advantage of Life Insurance Policies

The tax advantage of a life insurance policy depends upon how much cash value is earned. Regardless of the amount you earn, you defer the taxes of the cash value that you accumulate. The only time you will pay taxes is if the cash value you earned exceeds the amount that you have paid into your life insurance policy.

If you borrow against the cash value of your life insurance policy through a loan, then you will not have to pay income tax on the money. Instead, you just have to pay the loan back through the terms set forth in the loan agreement. Be advised that when you take a loan out against your life insurance policy, the loan is subject to a market value interest rate and it also can reduce the amount of the death benefit as well as the amount of the cash value.

It is very important not to let your policy lapse, especially if you have a loan out against it. In the event your policy lapses, you will be required to pay income taxes against any loan amount that exceeds the sum of the cash value and the amount of premiums that you paid. Furthermore, if you are under the age of 59 ½ you will be required to pay a 10% penalty tax.

Any cash value over the amount that you paid for your policy is subject to income tax at the time that it is withdrawn. Your beneficiaries do not pay income tax on the death benefit, so if your life insurance death benefit is $100,000 then your beneficiary will receive $100,000 and not owe taxes on it.

The decision to purchase whole life insurance or term life insurance will depend on several factors. Many prefer a whole life insurance policy if they can afford the monthly premiums. Others prefer to save money on a term policy and use the left over for investments they manage in other ways like stocks and mutual funds.

Most life insurance policies lock in the premium rate and are based on age, so the sooner you buy your policy, the less it will cost you each month. You can request quotes from different life insurance providers now by entering your zip code on this screen. Get started now!

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