Life insurance has several associated tax benefits. You also need to be aware of the potential pitfalls that can be associated with taxes as well. The relationship between taxes and life insurance can be quite complex, so you should consult with either your financial advisor or insurance agent to make sure that you understand fully all of the potential consequences in terms of how your insurance policy is set up. Here is an overview of potential benefits as well as problems when it comes to taxes and insurance.
One of the biggest tax benefits that comes with life insurance is that lump sum payments from claims on life insurance are only taxable when they are included in a deceased person’s estate. This is the case only when the deceased person is the one who owns the policy or when the deceased person has named either their estate or themselves as the beneficiary. Therefore, life insurance policies can be a great way to transfer income over to your family members when you die. Losses on state and federal estate taxes, if they do apply to you situation, can be offset by a life insurance policy to help make sure that your dependents will still be financially stable after your death.
People might also decide to receive the proceeds from life insurance in installment payments instead of one lump sum. When you do it that way, a portion of each installment payment is taxable due to the fact that part of the payment will be interest. In order to figure out how much of the insurance money every year is tax-free, you need to divide the total amount of the proceeds from the policy by the number of years that you are going to receive installment payments. The rest of the money is interest, and you will have to declare it on your tax return as taxable income for the years in which you receive the payments.
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If your insurance policy is through a mutual insurance company, then you may receive dividends each year. Dividend payments are the excess profits that a company distributes to the policy holders. How much you receive every year will vary depending on the value and type of your policy as well as the surplus of the mutual insurance company.
What is important to note is that these dividends are only taxable income when you receive a dividend amount that is more than what you paid for your premiums. For most people, it is very unlikely that this will happen. However if you do invest the money, any interest that you earn will be taxable and needs to be declared on your tax return for the year that you receive the interest.
Please note that the dividends that you receive in this manner is different from the dividends that you receive from insurance company shares that you own. Dividends that you receive as a result of owning shares will always be taxable, no matter how much you receive.
