Principal, LifeNet Insurance Solutions, Redmond, WA
Interest earnings within a life insurance policy are not taxable as are loans against the policy. However, the entire interest earnings WILL be taxable if the policy lapses for any reason, therefore you will want to contact the customer service dept. of the life insurance company prior to a lapse to find out the amount of interest earnings BEFORE you make such a decision.
When discussing the topic of taxes always consultant your account. However, the basic rule of thumb with life insurance goes like this.
A death benefit set up properly by your agent should not be taxed. On term life insurance there is no cash value so the only benefit is the death benefit.
On permanent life insurance plans such as whole life and universal life insurance, these plans do build a cash value that does earn interest. However, this is tax deferred interest, meaning as long as the plan is in force there is no tax on gains. When you withdraw funds from the cash value, you will have two options with two different tax consequences.
The first is if you cancel or lapse the policy and take the cash value, then yes, these proceeds or interest are taxed as income. However, if you borrow from your own cash value, then the IRS sees this as a loan and the funds are now tax free. I recommend speaking to your agent or advisor to avoid a costly mistake. The second loan aspect would almost always be preferred over cancellation to avoid taxes.
.JPG){kind=avatar}
A death benefit set up properly by your agent should not be taxed. On term life insurance there is no cash value so the only benefit is the death benefit.
On permanent life insurance plans such as whole life and universal life insurance, these plans do build a cash value that does earn interest. However, this is tax deferred interest, meaning as long as the plan is in force there is no tax on gains. When you withdraw funds from the cash value, you will have two options with two different tax consequences.
The first is if you cancel or lapse the policy and take the cash value, then yes, these proceeds or interest are taxed as income. However, if you borrow from your own cash value, then the IRS sees this as a loan and the funds are now tax free. I recommend speaking to your agent or advisor to avoid a costly mistake. The second loan aspect would almost always be preferred over cancellation to avoid taxes.