Why it matters
- Cash value life insurance policies can provide financial security and flexibility when the unexpected happens.
- This type of life insurance may also offer tax advantages, such as a federal income tax-free death benefit to your beneficiaries in most cases.
- With a cash value life insurance policy, you could also earn interest on the cash value component over time, allowing you to potentially grow your money tax-deferred until a later date.
Most of us understand the basics of life insurance policies. You pay premiums to an insurance company, and in return, the company promises to pay a benefit if someone covered by the policy passes. This is called a death benefit, which is typically paid federal income tax-free to your beneficiaries.1 But did you know that some types of permanent life insurance, like whole life, universal life, and index universal life insurance, come with a “cash value” component? This cash value is separate from the policy’s death benefit and the policyholder can use it in a variety of ways. It also offers some tax benefits most people don’t know about. Let’s take a closer look at those benefits.
Are life insurance premiums tax-deductible?
Whether you buy whole life, term life, or another type of life insurance, the premiums you pay are not tax-deductible for individuals. This holds true even if you’re self-employed—the IRS sees these payments as personal expenses, so there’s no tax break there.
However, businesses might be able to deduct these premiums.2 For companies, the IRS generally allows deductions for employee benefit programs, including life insurance policies. But there's a catch: If the policyholder has a financial interest in the business or is the direct or indirect beneficiary, the company can’t deduct those costs.3
Are life insurance proceeds taxable?
If you’re considering a life insurance policy, you’ll be glad to know that the benefit left to your beneficiaries is typically federal income tax-free. Life insurance payouts are not considered part of gross income, so they don’t need to be reported to the IRS.
There’s one exception. If the beneficiary decides to delay the payout, they’ll have to pay taxes on any interest earned while the insurance company holds onto the money.1
Cash value life insurance tax benefits
Cash value life insurance not only offers a federal income tax-free death benefit but may also provide some additional tax perks and flexibility.
With cash value life insurance, part of your premium goes into a cash value account after the cost of insurance and any fees are paid. This cash value has the potential to earn interest over time, and typically, you won’t pay taxes on the gains unless you surrender the policy or it lapses.4 This feature can be especially useful if you plan to withdraw the cash value when you retire and may be in a lower tax bracket.
It’s important to note that withdrawing the cash value will reduce the policy’s overall value and might increase the risk of the policy lapsing.4 Policy loans are tax-free as long as the policy is active, but if the policy is surrendered or lapses, any outstanding loan amount is treated as a distribution and taxed accordingly. Generally, you’ll only owe taxes on amounts that exceed the total premiums you've paid into the policy.5 A financial professional can help you understand the implications of taking a policy loan, including any potential taxes.
To wrap up, cash value life insurance offers flexibility and tax advantages, in addition to providing a death benefit for your heirs. For example, gains on the cash value portion grow tax-deferred, and loans taken against the policy aren’t subject to income tax as long as you don't borrow more than the amount you’ve paid in premiums and the policy isn’t surrendered or doesn’t lapse. If you're interested in exploring how cash value life insurance could fit into your long-term plans, it may be a good idea to speak to a financial professional.
Things to consider
- In addition to providing future financial protection, a cash value life insurance policy could provide tax-advantaged access to funds if and when you need them during your lifetime.
- If you’re looking for a way to build savings over time in addition to a traditional retirement account such as a 401(k) or IRA, a cash value life insurance policy may be an option worth considering.
- Talk to a financial professional to determine which type of life insurance policy may be a fit for your situation.
1 “Life Insurance & Disability Insurance Proceeds,” IRS.gov, August 2024
2 “Understanding Taxes on Life Insurance Premiums,” Investopedia, September 2023
3 “Is Life Insurance Tax-Deductible?” MoneyGeek, November 2024
4 “What Is Cash Value in Life Insurance?” Investopedia, September 2024
5 “How Can I Borrow Money From My Life Insurance Policy?” Investopedia, September 2024
Transamerica Resources, Inc. is an Aegon company and is affiliated with various companies which include, but are not limited to, insurance companies and broker dealers. Transamerica Resources, Inc. does not offer insurance products or securities. The information provided is for educational purposes only and should not be construed as insurance, securities, ERISA, tax, investment, legal, medical or financial advice or guidance. Please consult your personal independent professionals for answers to your specific questions.
