When you are deciding on the perfect life insurance policy to fit your lifestyle you’re typically given the options of a whole life or term life policy. While each program has its respective pros and cons, today we are going to take a closer look at the tax differences.
Understanding the taxing of whole life insurance is a major necessity of anyone looking into life insurance. Making a wrong decision with your plan could cost you tons of money down the road at times where you just simply don’t have it to give. Save yourself from unwanted financial hardships later by learning about whole life taxing today.
Tax Advantages of Whole Life Insurance
Tax-Free Death Benefit
All the money from your life insurance policy will be spread amongst your named beneficiaries upon your death. This eliminates the very unpopular inheritance tax that many end up paying on money distributed from a will. One important factor to note is that term life insurance policies will provide this tax-free death benefit, but only if the policyholder passes during the coverage period.
If you manage your policy correctly, you can take advantage of tax-free loans. These work to give you cash for things like supplementing retirement expenses or college funding. The loan amount is withdrawn in a similar fashion to the death benefit, so you don’t need to pay it back.
Tax Consequences And Other Downfalls of Whole Life Insurance
The major consequence that everyone thinking of purchasing a whole life insurance policy should know, is that their policy can become taxable under certain circumstances. Potential problems that can change your whole life insurance policy include a lapse, surrender, and termination by the insurance company.
Insurance companies hold the right to terminate your life insurance policy if the cash value of the policy is less than the policy loan and interest accrued. This is typically easier to understand with an example.
For a whole life insurance policy, you’re given the benefit of tax-free loans. Let’s say you have a $10,000 policy. The loan you need is for $9,000, which leaves $1,000 left in your policy. You decide to use that remaining $1,000 to pay the accumulated interest on your loan. When the interest on your loan exceeds that $1,000 amount, your total loan is over the cash value of the policy. The $9,000 plus the accumulated interest of over $1,000 add up to more than the $10,000 amount the policy is worth.
In this case, your insurance company will offer two options. Either you can fund the policy with more money or they will terminate the policy. If the policy is terminated it will make the loan no longer tax-free.
One other downfall to keep in mind is that whole life insurance policies cost more than traditional term policies. If you spend a large portion of your life paying the higher premium for a whole life policy, but then are hit by financial hardship and let your policy lapse you just spent a lot more money than if you would have gone with a term policy.
One of the major deciders for persons who opt for whole life insurance over term life insurance is the tax-free benefits. However, if you don’t understand how to manage your policy correctly, you could end up paying taxes or surrendering your policy. This would negate the benefit of whole life insurance and the costs will be more than a traditional term policy. Understanding the tax consequences for a whole life policy is imperative for the success of your future finances.