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Earning Tax Credits for Life Insurance

The main purpose of a life insurance policy is to provide financial stability after the death of a loved one. Aside from that fundamental benefit, some tax benefits can come with certain types of life insurance policies. Dependents could reap these tax credits when they receive benefits, or the insured individual can use them before the insurance policy pays out. Such policies typically benefit the very wealthy, helping them to minimize estate taxes. Because these policies carry a much higher premium cost, they rarely make sense for those with smaller incomes. Those individuals typically fare better with term life insurance.

Tax-Free Benefits

Basic tax benefits that go along with every type of policy are the policy proceeds. When the insured individual dies, the beneficiaries receive any life insurance payouts tax-free. The proceeds are tax free regardless of the type of life insurance policy. People who purchase whole life insurance can also benefit from a tax break because the policy’s earnings are not taxable for the duration of the policy. This means that the investments made by the whole life insurance policy will not be taxed until the policyholder’s death and the disbursement of the earnings to beneficiaries.

Cash Value Accumulation

One of the possible tax credits that people may not be aware of is the cash value accumulation. When the single premium value of the life insurance policy matches or exceeds the amount of the potential payout, there are no taxes due on the payout. This tax advantage only applies if the premium value is the same as or more than the overall benefit amount. If the single premium is less than the value of the policy, the earnings collected through premium payments do not qualify as life insurance benefits and will be taxed accordingly.

Guideline Premium

The federal government has placed specific guidelines on the amount of money paid toward a life insurance policy before the policy qualifies as life insurance. If the payments meet the appropriate guidelines, the policy qualifies for tax-free status. The general guideline states that the amount paid into the policy cannot exceed the guideline level premiums or the single guideline premium costs. That means the insured individual cannot pay more in premiums than the policy cash value.

Corridor Test

The corridor test is a process that evaluates the amount of money paid into the policy through premiums compared to the cash value of the policy. To continue to qualify as life insurance so that there will be no taxes assessed upon payment of benefits, the amount of money paid into the policy through premiums must be a specific percentage of the overall value of the benefits. The insurance corridor is the amount of money included in the death benefit that premiums have not yet covered. That balance of benefits would be tax-free.

Jessica Bosari writes about financial planning and life insurance for TermLifeInsuranceNews.com. The site offers news, advice and life insurance information for consumers.