Life insurance policies offer several prime tax advantages. In most cases, the money the beneficiary receives is free of income tax. That’s true even if only, say, $2,500 was paid in premiums and the beneficiary collects $250,000.
Permanent life (cash value) policies offer two additional tax benefits:
* Tax-free buildup. Inside the cash value, investment income might be generated. As long as cash stays inside the policy, that income usually won’t be subject to income tax.
* Tax-free payouts. Policy withdrawals are not taxable, up to the total amount paid in premiums. In addition, loans also might not be taxable, as long they are taken in moderation.
However, taking withdrawals and loans may reduce the policy’s cash value and death benefit. If you overdo loans and withdrawals, the policy can lapse and trigger an income tax obligation. Therefore, a cash value life insurance may be a source of funds, tax-free, but distributions should be taken with care.