Not everyone has the exact same financial plan, and that’s okay, but the basis and purpose of it is almost always the same: to make the future financially secure. Now, as we talk further about insurance, we also need to understand the hidden benefits we must make the most of. Many times people might back off from taking up life insurance because they’re factoring in the taxes they’ll have to pay once they cash out the benefit. Life insurance is one of those few financial security instruments that doesn’t come under the strict radar of taxation. Check out for term insurance quotes online to understand how different policies work differently and include exemptions too.
Taxation is a tricky subject, no doubt, and it’s important to know all the nitty gritties before deciding to commit. While life insurance isn’t 100% exempt from taxation, there are several situations where this benefit can be availed. Policies and policy guidelines have seen quite a shift over time, with monetary laws making it easier and more favorable for people to opt for securities like insurance. This very well may be a bid to get more people to invest in it because the advantages are a two-way street.
Below we’ve listed some of the tax benefits you can avail when you opt for life insurance, hoping to clear the air and answer some of your questions regarding the matter.
An important factor to remember is that taxation works differently with term life insurance and permanent life insurance. For term insurance, the policy benefit is only on the basis of death, which is the insured amount and nothing more. Whereas with permanent life insurance one can avail the policy amount plus a cash-value component which adds on to the benefit. The advantage here is that this cash-value is non-taxable in most cases, and that’s how smart investors make use of the exemption to plan for further security. Whether it’s as income replacement or for a solid retirement fund, permanent life insurance is a very interesting option.
Now, let’s look at the tax exemption benefits for permanent life insurance:
- Growth that is tax-deferred
If one decides to withdraw a substantial or whole policy amount before death, along with the growth in the cash-value, this entire withdrawal would be taxed as ordinary income only and not as additional income. The great part about this is that one can add on a cash-value amount and let it mature over time, as a bonus to the already settled on coverage of the policy. The only if here is that the amount needs to be withdrawn before death, or else the cash-value could be lost. In many cases, withdrawal after death would mean that only the policy coverage amount would be received by the beneficiary, while the cash-value or most of it would be absorbed by the insurance company itself, on the pretext of various clauses and concerns. With this option, you get a larger withdrawal amount but only pay the taxes that you were originally supposed to pay. Hence the win-win!
- Dividends being tax-free
If paying regular premiums is becoming a hassle, or you have the plan to increase your coverage amount but don’t have the funds for it, then taking our dividends on your life insurance policy is a great option. The dividend hence received doesn’t come under the taxation bracket, because it’s considered a return of the premium being paid. In a rotational cycle, one can take a larger coverage amount or even use the dividend to pay the regular premium, with the ultimate advantage of not losing out on the policy itself. However, to avail this tax-free benefit, you must ensure that the dividend taken doesn’t actually exceed the amount of the premium itself. Anything excess would definitely come under the taxation scanner because it counts as additional income. So, while planning this out, remember that the benefit you receive after death will be completely tax-free, but you won’t win any additional dividend amount because that gets absorbed by the may insurance agency.
- Cash withdrawals
Cash withdrawals are when you take money out of the policy before the occurrence of death, and yes, that does come under the tax-free category. Many people decide to withdraw cash from policies during emergencies and times of need. The catch is that the withdrawn amount has the be equal to or lesser than the amount which would be the sum of the premiums paid thus far. Any withdrawal made within that amount wouldn’t be taxed, but the next decision you’d have to make is whether to just make a withdrawal or cancel the policy as well. Surrendering the policy would involve a few charges from the company’s side, including a surrender charge. Alternatively, if you do make a withdrawal surpassing the amount of the premiums paid, then that additional amount would’ve been taxed as gain. Hence, the smartest solution would be to withdraw just the right amount, allow the policy to mature further, and also not have to pay taxes on the withdrawn amount.
- Alternative loan solution
Whether or not you’re eligible to take a loan from a bank, there’s always one option that you can consider: taking a loan on your life insurance policy. You can use the cash value of your policy as a security for your loan approval, as long as the loan amount doesn’t surpass that limit. This benefit of using the policy as security is tax-free because you’re not technically using or withdrawing any money from the policy coverage itself. As long as there is no displacement of actual funds, you can make the most of this benefit without spending your money. However, the most basic yet vital clause is that you pay off your debts on time and not have any arrears in payment, because the unpaid loan amount, along with the specified interest rate, would be deducted from the final coverage of the policy itself in case of a death. So, instead of losing out on policy money, the wiser choice would be to use the policy as a tax-free security and make sure that your end benefit from the policy stays unaffected.
Final Thoughts
Where there’s a will, there might also be a loophole! Exemption from tax can be a substantial saving of money, which you could otherwise use to improve your financial status. Life insurance in one such area where you can legally and ethically save tax money, and also create a haven for future expenses. If you’re doubtful about these exemptions, we hope our list has helped you answer some queries!
