Life Insurance and Taxes

 Life Insurance is usually purchased with the intentions of leaving your loved ones with a way to pay for burial expenses and perhaps to help clear up any debts you may leave behind. However, these days it is a common way to invest and leave money to your loved ones without paying incredible estate or inheritance taxes. It is this last reason for purchasing life insurance that may make you more prone to asking.

Lets first understand about how insurance works. When you purchase most types of an insurance policy, you either pay an initial sum or pay it out in premiums. This payment amount is usually invested by the insurance company into stocks, bonds, mutual funds, etc. This allows the value of the money you first put down to grow considerably. The money earned in an insurance policy is tax-deferred, meaning that until the policy is terminated or the money is paid out, the money is not taxed. But at the time of pay-out or termination, the money is taxed as income.

With life insurance, the premiums are paid after-tax. This means that the money paid to beneficiaries on the policy will be tax free. Basically, you paid them when you purchased the policy. Let’s look at the difference between and annuity and a life insurance policy. With an annuity, you pay premiums, it’s invested, and upon payout it is considered to be income to the beneficiary or policyholder. Thus it is taxed as income. However, with life insurance, the money put down for the premium has already been taxed, and it’s left to grow until the person named in the policy dies. The money then is paid out, tax-free, to the named beneficiary/ies.

It is common to use life insurance policies to pass down money, like an inheritance, and help reduce estate taxes. Your loved ones receive more this way. You should be aware of all legalities associated with estate planning and the best way to go about leaving an inheritance to your loved ones.

Regardless of the reason for purchasing life insurance, it is important to know how it is taxed.