Is Life Insurance Tax Deductible?
*Article prepared by Northwestern Mutual with the cooperation of Chris Welton, Wealth Management Advisor for Rob McCarthy, 101 Loan LLC.*
By Carl Engelking, October 06, 2021
Life insurance can be an important part of your financial planning. With permanent life insurance, in addition to a guaranteed death benefit that is typically tax-free, your policy will build cash value that can accumulate over time in a tax-advantaged way.
Are life insurance premiums tax-deductible?
If you hopped on the internet for a quick answer to this question, we’ll save you some time: for the most part, no, they aren’t, but there is one exception (more on that in a moment).
Life insurance premiums are considered a personal expense, and therefore not tax deductible. From the perspective of the IRS, paying your life insurance premiums is like buying a car, a cell phone or any other product or service. There’s also no state or federal mandate that you purchase life insurance, unlike health insurance, so the government isn’t offering you a tax break in this case.
Although premiums aren’t tax deductible, there are several tax benefits of a life insurance policy.
Business-paid premiums may be tax-deductible
If you’re a business owner, you can deduct business-paid premiums for life insurance policies that are owned by company executives and employees, and the executive or employee reports the premium as income.
OK, so your premiums aren’t tax deductible, but Uncle Sam still offers several tax breaks for life insurance policies.
Permanent life insurance cash value may be tax-deferred
Permanent life insurance policies, for example, feature a cash accumulation component in addition to coverage for your entire life. Cash value in a life insurance policy grows over time, and taxes are deferred on the growth. Once your cash value has grown it can be used as collateral on a loan, to pay for college, a house or even your premium payments1. If you surrender your policy, your cash value will typically be tax free up to your “basis”, or the amount of money that reflects your total premium payments. Any amount above the basis is considered a gain and would be taxed as ordinary income. Whole life, variable life and universal life are some of the most common types of cash value life insurance.
Permanent life insurance dividends are typically tax-free
Generally, cash dividends2 received from a life insurance policy are also tax free and don’t need to be reported as income, so long as the amount doesn’t exceed the net premiums you’ve paid on the policy. That’s because dividends are considered a return of policy premiums – you paid too much, so you get your money back.
Another huge tax advantage: Proceeds from a life insurance death benefit are generally tax free. Your family will be protected from financial hardship, and that payout won’t be considered income. However, if it is paid over time and the insurance company adds interest, those interest payments will be taxable. A financial professional can discuss how life insurance, and the accompanying tax benefits, can fit into a long-term plan.
1Each method of utilizing your policy’s cash value has advantages and disadvantages and is subject to different tax consequences. Surrenders of, withdrawals from and loans against a policy will reduce the policy’s cash surrender value and death benefit and may also affect any dividends paid on the policy. As a general rule, surrenders and withdrawals are taxable to the extent they exceed the cost basis of the policy, while loans are not taxable when taken. Loans taken against a life insurance policy can have adverse effects if not managed properly. Policy loans and automatic premium loans, including any accrued interest, must be repaid in cash or from policy values upon policy termination or the death of the insured. Repayment of loans from policy values (other than death proceeds) can potentially trigger a significant tax liability, and there may be little or no cash value remaining in the policy to pay the tax. If loans equal or exceed the cash value, the policy will terminate if additional cash payments are not made. Policyowners should consult with their tax advisors about the potential impact of any surrenders, withdrawals or loans.
2The dividend scale and the underlying interest rates are reviewed annually and are subject to change. Future dividends are not guaranteed, although Northwestern Mutual has paid a dividend every year since 1872.
This publication is not intended as legal or tax advice. Financial Representatives do not give legal or tax advice. Taxpayers should seek advice based on their particular circumstances from an independent tax advisor.
Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company (NM) and its subsidiaries in Milwaukee, WI. Christopher Edward Welton is an Insurance Agent of NM.