Although cash value life insurance is frequently tax-advantaged, withdrawals may be subject to taxation. Enter ZIP Code.
Any life insurance policy that offers both a death benefit and a savings component is considered a cash value life insurance policy. The cash value savings component allows you to accumulate wealth while you pay your premiums. Because this money is accessible to you for the duration of your life, cash value life insurance is a desirable living benefit. Term life insurance and other non-cash value life insurance plans do not have a savings component.
If you’re considering purchasing a cash value life insurance policy, you may be curious about the workings of the cash value component, particularly with regard to taxes. In certain circumstances, cash value income is subject to taxation, while it is not in others. We’ll look more closely at when cash values are taxed in this guide, along with some tips on how to keep your accrued cash value tax-free.
Understanding the Tax Implications of Surrendering Your Life Insurance Policy
Life insurance can be a valuable financial tool, offering both protection and potential wealth accumulation through its cash value component. However, there may come a time when you consider surrendering your policy, exchanging it for a lump sum payout. While this can provide immediate access to funds, it’s crucial to understand the potential tax implications of this decision
Taxability of Cash Value Life Insurance Proceeds
In general, the death benefit of a life insurance policy, including cash value policies, is not taxable when received as a lump sum by the beneficiary. This means that your loved ones won’t have to pay taxes on the full amount they receive upon your passing. However, there are exceptions to this rule, such as when the beneficiary chooses to receive the payout in installments or through an annuity In such cases, the beneficiary may be liable for taxes on any interest earned on the remaining benefit.
Taxation of Cash Value Withdrawals and Surrenders
While the death benefit itself is typically tax-free, withdrawals or surrenders of cash value during your lifetime can trigger tax consequences. The taxable portion of a cash value withdrawal or surrender is the amount exceeding your policy basis, which represents the total premium payments you’ve made. This taxable amount reflects the investment gains you’ve accumulated within the policy.
Scenarios Triggering Tax Consequences
Several scenarios can lead to tax implications when surrendering your cash value life insurance policy:
- Receiving more funds than the policy’s cost basis: If the surrender value exceeds the total premiums you’ve paid, the difference is considered taxable income.
- Outstanding policy loans exceeding the policy’s cost basis: If you have outstanding loans against your policy that exceed the total premiums paid, the difference is also taxable.
- Changes in your cost basis: Any adjustments to your cost basis, such as reducing the death benefit or adding riders, can impact the taxable amount upon surrender.
Minimizing Tax Consequences
To minimize potential tax liabilities associated with surrendering your life insurance policy, consider the following strategies:
- Withdraw only what you need: Instead of surrendering the entire policy, consider withdrawing only the amount you require, keeping the policy active for continued protection and future cash value accumulation.
- Borrow against your cash value: Taking a loan against your cash value can provide access to funds without triggering tax consequences. However, remember that interest accrues on outstanding loans, and failure to repay could lead to policy lapse.
- Consult with a tax professional: Seeking guidance from a qualified tax professional can help you understand your specific tax situation and develop strategies to minimize your tax liability.
Alternatives to Surrendering Your Policy
Before surrendering your policy, explore alternative options that allow you to access your cash value while maintaining coverage:
- Borrowing against your cash value: As mentioned earlier, you can take a loan against your cash value at favorable interest rates and terms.
- Withdrawing from your cash value: While withdrawals may trigger tax consequences, they allow you to access your funds without surrendering the policy.
- Using your cash value to pay premiums: Many policies allow using your cash value to pay future premiums, reducing your out-of-pocket expenses.
Surrendering your life insurance policy can provide immediate access to funds, but it’s essential to be aware of the potential tax implications. By understanding the taxable scenarios and exploring alternative options, you can make informed decisions that align with your financial goals and minimize your tax burden. Remember to consult with a tax professional for personalized advice regarding your specific situation.
Selling Your Life Insurance Policy
Some policyholders sell their policies — frequently to an investor — for an immediate cash benefit. Did you know that you can do that? Perhaps you no longer require your policy, or perhaps you require funds to meet pressing needs. When an investor purchases your policy, they pay the premiums and receive benefits. When you die, the investor receives the entire death benefit.
There are two types of in-force life insurance sales:
- Viatical settlements: A viatical settlement is when a terminally ill person sells an investor their policy. For instance, a patient with cancer might require cash right away to pay for their high medical expenses.
- Life settlements: In a life settlement, an investor purchases an insurance policy, but the seller is typically in good health. A healthy senior may choose to sell their policy for a variety of reasons, including to reduce the cost of insurance premiums or to offset rising living expenses.
Compared to life settlements, viatical settlements usually have substantially larger payout offers. Investors in viatical settlements understand that their money is probably going to be returned sooner than in a life settlement because a terminally ill person may pass away before a healthy person.
The tax advantages of a viatical settlement versus a life settlement also differ significantly. The money you receive as a viatical settlement when you sell your insurance policy is regarded as a kind of death benefit payment and is not subject to taxation. However, life settlement payments are regarded as taxable income, so a portion of the proceeds will likely need to be paid in income taxes by the sellers.
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Cash Surrender Value of Life Insurance – Tax Implications
FAQ
How is surrendered life insurance taxed?
Is cashing in life insurance taxable?
What happens when you surrender life insurance policy?
Do you get a 1099 for life insurance proceeds?
Do you owe taxes if you surrender life insurance?
However, it’s helpful to know that getting the cash surrender value may cause you to owe taxes in certain situations. This article will explain how the cash surrender value of life insurance works and cover the tax implications of surrendering your life insurance policy with cash value.
Are life insurance surrender payouts tax-free?
The amount of your life insurance surrender payout that is taxed as income depends on the premiums you have paid into the policy. The total of premiums you have paid into the policy is known as the cash basis. When you surrender the policy, the amount of the cash basis is considered a tax-free return of principal.
Should you surrender a life insurance policy if you need cash?
If you need cash from your life insurance policy, terminating the contract isn’t the only option. Consider these alternatives to surrendering a policy. Borrow against the policy. You can take out a loan for up to 90% to 95% of the cash value of a policy. You’ll need to pay interest on the loan.
What happens if you surrender a life insurance policy?
When you surrender the policy, the amount of the cash basis is considered a tax-free return of principal. Only the amount you receive over the cash basis will be taxed as regular income, at your top tax rate. However, remember that for every $100,000 in coverage, only an average of $460 is received in surrender benefits.