Life Insurance Tax Advantages
Under the current Internal Revenue Code, life insurance has a unique combination of tax advantages that are not available with any other financial, investment, or cash accumulation product (1).

1.	Tax deferred accumulation of cash values
2.	Tax free income via withdrawals and policy loans
3.	Income tax free proceeds to policy beneficiaries at death

Tax deferred accumulation of cash values

The basic reason to own life insurance is to provide for your family’s financial security in the event of a premature death. However, a secondary motive for buying life insurance, specifically whole life or universal life, is the advantage of tax deferred cash value growth.
With universal life insurance, for example, cash values will accumulate over time if actual premium payments exceed the policy’s expenses and insurance costs. Each year, interest is credited to the policy’s cash value based on an interest rate established by the insurance company. Cash values will continue to grow tax deferred, as long as insurance costs and fees are covered, until they are withdrawn, borrowed or the insured dies. For more information on tax deferred cash values with universal life see, “How a universal life insurance policy works.”
The advantages of tax deferred growth can also be found in other financial and investment products. Annuities and qualified retirement accounts are just two examples of products that also offer tax deferred growth of accumulated values. However, life insurance is the only cash accumulation product that offers the combination of tax deferred growth of cash values with the ability to structure cash distributions that may be received tax free.

Tax free income via withdrawals and policy loans

The second tax advantage found in permanent life insurance policies, including whole life, equity-indexed life, or universal life, is that cash value distributions may be accessed from the policy tax free. If structured properly, policy withdrawals and loans can be used to essentially eliminate income taxes on cash received from a life insurance policy.

Withdrawal of cash value from a life insurance policy is generally not taxable as long as the amount withdrawn does not exceed the policy premiums that have been paid to date, also known as the policy’s basis. The Internal Revenue Code Section 7702A provides the definition of life insurance for tax purposes. For specific details on IRC 7702A see, “The IRC and Life Insurance Tax Strategies.” As long as the life policy qualifies under IRC 7702A, and is not classified as a modified endowment contract (MEC), withdrawals are not subject to tax until cash value’s withdrawn exceed the policy’s premium basis. Once the policy’s basis has been withdrawn, future withdrawals are subject to income taxation.

To avoid taxation on policy distributions above the policy’s basis, policy loans can be used to access additional cash values tax free. As long as the insurance policy is not considered a MEC, policy loans are not taxable. If cash values are received via policy loans, there is no income tax on the amount borrowed, but loan interest will be charged by the insurance company on any outstanding loan balance. Policy loans do not have to be repaid. However, if an outstanding loan is not repaid before the insured’s death, the policy loan balance including any unpaid interest will be deducted from the policy’s death benefit.

Even though policy loans are not taxed, there are certain conditions when taxes on loans may apply. For example, if a policy is surrendered or lapses, income taxes will apply. When a policy is surrendered, any amount of cash values actually received in excess of the policy’s basis will be subject to income taxation. Existing policy loans are then considered cash distributions and included in the calculation of the policy basis. When a policy lapses, any outstanding loans are treated as cash value distributions and subject to taxation on any amount in excess of the policy basis. Policy lapses may have a devastating effect on existing policy loans as there will be no cash available from the policy to potential taxes. For this reason, many companies offer lapse protection riders that are available on policies where cash accumulation is a primary objective.

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Income tax free proceeds to policy beneficiaries at death

Under the current IRC, life insurance death benefits are payable to a named beneficiary are received income tax free. When an insured dies, life insurance policy proceeds less any policy loans and accrued interest are customarily paid to the policy’s beneficiary(s) in one lump-sum. This lump-sum is free from any income tax.

Tax advantages make life insurance a great option

Life insurance has a unique combination of tax advantages including tax deferred growth of cash values, tax free income via withdrawals and policy loans, and tax free death benefits. This combination of attributes is not found in any other cash accumulation product. These special tax features make equity indexed universal life, whole life or universal life a supreme solution for cash growth, supplement retirement income and family security protection.

(1) The above tax information is for information purposes only and is provided to explain the basic tax treatment of life insurance based on the Internal Revenue Code. Any individual or entity considering any life insurance policy should consult with their own independent advisor that understands their particular tax circumstances. This information is not intended to be tax or legal advice.

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