Tax season is just around the corner, and your clients might be curious about tax impacts on their life insurance policy when filing this year. Taxes are a minefield of red tape and obscure laws, and sitting with your clients to discuss how life insurance gets taxed can give them some peace of mind and guidance this year.
Here we will break down four specific areas where taxes do or do not come into play. By keeping yourself educated on the specifics, you can help your clients be prepared for this tax season.
Key takeaways:
- Good news for your clients: life insurance death benefits are typically not subject to taxation
- Annuities are an excellent vehicle for your retirement-planning clients. Their payments will be tax-free, but clients might end up paying taxes once they start drawing from the final amount.
- By keeping yourself educated on what is tax exempt and what needs to be claimed, you can keep your clients up to date and prepared for this tax season.
#1: Tax-free payments
The first thing for your clients to know is how their policy payments are being taxed (or the lack thereof). Since life insurance policies are chiefly intended to support the client’s beneficiaries, the IRS categorizes them separately from other financial products. Under most circumstances, premiums paid on a life insurance policy are tax-free.
Your clients’ payments to their policy will not garner any additional payments to the IRS and instead will count only toward the policy itself.
There are some exceptions to this, for instance, if the client has a life insurance policy through their employer (and the employer pays more than $50,000 in coverage) then the IRS will consider this income and it can be taxed.
#2: Death benefits
Who your clients choose as their beneficiaries is important to the reason behind their purchasing a policy. They want to know that the investment they’re making is going to financially support their loved ones when they’re no longer around. With that in mind, they’ll be curious to know how the death benefit is affected by taxes.
Good news for your clients: life insurance death benefits are typically not subject to taxation . Specifically, death benefits that are paid in a lump sum are not ordinarily taxed. However, if the beneficiary instead receives installments that include interest it might be taxed.
Similarly, your clients can rest easy knowing that their death benefit is exempt from creditors in most cases . The exception to this would be if your client’s beneficiary is their spouse and the debt they have involves a loan that is co-signed by the beneficiary.
#3: Annuities
Annuities are popular savings vehicles for your clients preparing for retirement. With an annuity, your clients can invest in their life insurance products to generate an additional stream of income later in life. While they’re paying their premiums (also known as the accumulation phase) they’ll be happy to hear that their money is growing tax-free during the lifetime of their contract.
However, once your clients begin drawing on the annuity, they will want to be more aware of how it’s being taxed. The money generated by the annuity (even though it accumulated without being taxed) will be considered an income and as such liable to be taxed.
If your client decides to draw on the annuity before it matures completely, they may be subject to even more monetary penalties and higher taxes. With that in mind, they’ll want to be sure to discuss any earnings with you before deciding to withdraw.
Still, there are riders like the income rider that can help them avoid those harsher penalties. With an income rider, your client can use the annuity’s tax-free earnings at any time instead of waiting for the specified age attached to the product. Beyond that, you might also consider discussing critical illness riders with them that waive certain penalties if they are diagnosed with an illness during the covered term.
Ultimately, annuities are an excellent vehicle for your retirement-planning clients. While their payments will be tax-free, they might end up paying taxes once they start drawing from the final amount.
#4: Cash value policies
Speaking of retirement vehicles, if your clients are interested in a whole or universal life insurance policy, they might also be looking into the benefits of a cash value component . A cash value option is ideal for clients who have maxed out other retirement options like IRAs or 401(k)s.
This April, your clients will be especially grateful for the tax-free benefit of opting for a cash-value policy. All the money saved will not be taxed and can grow so long as the policy is in force and your client is still making payments to the policy.
However, there are instances where your clients may have to face taxes when accessing the cash value of their policy. Your clients will have a few different options when it comes to using the cash value of their coverage. They can make partial withdrawals, borrow against the amount of the policy, surrender the coverage or even use the cash value to make payments on the policy.
Depending on the length of time the cash value has matured, any of these options can result in taxes for your client. The deciding factor will normally be influenced by the amount being withdrawn . To that end, surrendering the policy will typically be the option most commonly taxed.
If you have clients considering a cash value policy, be sure they understand the effects of each option when it comes to using the accrued amount. While their payments will grow tax-free, it’s less likely that drawing on the cash value will be similarly affected.
Help them prepare with Symmetry
Taxes are a struggle, and your clients might have questions about how their life insurance is being taxed and what they need to know when filing.
By keeping yourself educated on what is tax exempt and what needs to be claimed, you can keep your clients up to date and prepared for this tax season. They’ll be happy to know how much life insurance grows tax-free.
