Life Insurance Tax

Life Insurance Tax: Every year, or so it seems, the Congress of the United States tries to devise ways of taxing life insurance--including the death benefit. In an instance of good government lobbying by private enterprise, the life insurance lobbyists come together in Washington and shoot that down. Which is good news for consumers.

Life insurance's most powerful benefit is its tax-free and tax-deferred set of components. Death benefits are never taxable in most cases; however, people with large estates (those exceeding, at the time of this writing, $2 million at the time of death) who have a life insurance policy included in their net assets can find their death benefits subject to taxation; these people will want to turn over their life insurance policy to their children or executors through a trust fund (they will want to seek legal counsel and be serviced by a Certified Financial Planner, or CFP, in so doing this, so that they make sure they do not violate the IRS transfer-for-value rules under Sec. 101(a)(2) of the U.S. tax code; planning should be done years in advance if possible).

Life insurance also can be used to build a substantial amount of money in a tax-sheltered account. As a matter of fact, more and more financial advisors and planners are advising clients to use universal life insurance policies as investment vehicles precisely because of their tax-sheltering power.

Universal life insurance policies, as well as whole life policies, are not taxed for capital gains or income tax as cash value grows within them. Financial professionals are much, much more keen on universal life than whole life because the former offers more control over payments and much greater potential returns on investment. Only when the policy holder withdraws money from or borrows money out of the policy can there be a taxable event. However, premiums are considered to come out first; that is, if a person has paid $5000 in premiums into a policy before withdrawing cash from it, the first $5000 are not taxed because they are considered to have already been taxed, as there is no tax credit for premiums. Taxes are based on the policy holder's income tax bracket at the time of withdrawal, too.

Therefore, given the above, it's the wisest course of action to let a life insurance policy grow money tax-deferred for a long time, for decades if possible, while funding it steadily throughout that time. When the time comes to take cash out of it, do so slowly and gradually.

One life insurance product that has been around for a long time that helps to beat the life insurance tax man is the annuity. According to Investopedia, the life insurance tax sheltered annuity is "a type of annuity that allows an employee to make contributions from his or her income into a retirement plan. The contributions are deducted from the employee's income and, as a result, the contributions and related benefits are not taxed until the employee withdraws them from the plan. Because the employer can also make direct contributions to the plan, the employee gains the benefit of having additional life insurance tax free funds accruing.

"In the U.S., one specific tax-sheltered annuity is the Internal Revenue Code's Section 403(b) plan. This plan provides employees of certain non-profit and public education institutions the benefit of having a tax-sheltered method of saving for retirement. There is usually a maximum amount that an employee can contribute to the plan, but sometimes there are "catch-up" provisions that allow employees to make additional contributions to make up for previous years where they did not make the maximum contribution."

All people who are serious about their financial security and future should consult with financial professionals about the ways they may use life insurance to beat the tax man.

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