Is Interest on Life Insurance Taxable?
Life insurance is primarily used to provide money to pay for your expenses after your death, any outstanding financial obligations or to leave a charitable gift to a non-profit organization. But some life insurance policies provide living benefits in the form of a cash value savings. This savings earns interest, and you must know how this interest is treated by the IRS.
Other People Are Reading
-
Function
-
Life insurance that earns interest is cash value life insurance. This type of life insurance builds a cash reserve, called a cash value, and is invested in either fixed or variable investment products. Examples of cash value life insurance include whole life insurance, variable life insurance and universal life insurance.
Benefit
-
Cash value life insurance provides a savings you may use during your lifetime for any reason. This savings earns interest that is not taxed as it is credited to the policy's cash value account. Additionally, interest values may be accessed through life insurance policy loans that are tax-free. This provides you with a way to use interest earnings on a tax-free basis where you would not otherwise be able to do so.
-
Disadvantage
-
The disadvantage to life insurance is that if the policy ever lapses during your lifetime, then any outstanding policy loans are forgiven and treated as income. Additionally, all gains in the policy are taxed at ordinary income tax rates. A gain is any amount of money in excess of the total premiums paid into the policy. Finally, any withdrawals made from the policy in excess of the total premiums paid to the policy are taxed at ordinary income tax rates.
Consideration
-
Before purchasing a life insurance policy, consider what you want to use the policy for. Cash value interest can be used to supplement your retirement income, send your children to college, provide a down payment on a home or for any other purpose. But keep in mind that the interest only remains tax-free if the policy stays in force. Consider repaying any policy loans you take and do not take excessive withdrawals so that you avoid paying tax on your life insurance policy.
-
