In this article, you will learn
- What percentage of an insurance company’s premium is subject to taxation?
- What is employer-Paid Life Insurance?
How much percentage of an insurance company’s premium is subject to taxation?
When purchasing life insurance, it’s critical to think about the tax ramifications. The Internal Revenue Service (IRS) applies different tax regulations to other plans, which can be arbitrary at times. The information is intended to help you understand some of the tax implications of life insurance premiums.
The First Thoughts
Before purchasing life insurance, a shopper must examine some factors. There’s the contrast between term and whole life insurance, for starters. A term life policy lasts for some years, but a whole life policy lasts for the rest of your life. 1 A policyholder must also determine how much coverage they require. This is primarily dependent on why they are purchasing life insurance.
You may choose a death benefit of $20,000 or less if you are just concerned with financing your burial and funeral costs for your family. If you have numerous dependent children, all of whom you want to send to college in the future, you will most likely need coverage of $500,000 or more. Many life insurance firms pick further complicates the purchasing process. The Internet has made this process a little easier, with some websites dedicated just to comparing quotations from dozens of different life insurance carriers.
Premiums for life insurance are taxed.
Unlike buying a car or a television, buying life insurance does not involve the payment of sales tax. This means that the premium you offer when applying for coverage is paid in full, with no tax applied. With that said, certain instances exist in which a policyholder is compelled to pay taxes on insurance premiums.
Employer-Paid Life Insurance
When an employer includes life insurance as part of a total compensation package, the IRS considers it income, and the employee must pay taxes on it. These taxes, however, only apply when the employer pays for life insurance coverage worth more than $50,000. Even in those situations, the premium cost for the first $50,000 in coverage is tax-free.
If, for example, an employer provides a $50,000 life insurance benefit to an employee in addition to their health benefits, salary, and retirement savings plan for the duration of their employment, the employee does not have to pay taxes on the life insurance benefit because it does not exceed the IRS’s threshold.
Alternatively, if the employer provides $100,000 in life insurance coverage, the employee must pay taxes on a portion of it. The premium funds used to pay for the $50,000 in coverage they get more than the IRS threshold are taxed. So, if the monthly payment is $100, the additional $50,000 coverage, or $50, is taxed.
Life insurance that has been pre-paid
Some life insurance policies allow policyholders to pay a one-time lump sum premium. Throughout the plan’s duration, that money is applied to the premiums. Interest increases the value of the lump-sum payment. The IRS considers the growth of that money to be interest income, which means it can be taxed whether the money is used to pay a premium or when the policyholder withdraws some or all of the money gained.
Plans with a Cash Value
Many life insurance policies accumulate capital value as policyholders contribute their premium money and offer a guaranteed death benefit. A portion of the premium money is put into an interest-bearing account. It is usual for the cash value of a plan to exceed the number of premiums paid by the policyholder, especially with long-term plans. People invest in this sort of life insurance while also benefiting from the protection it offers their families in the case of an unexpected death.
Many financial counselors are adamantly opposed to utilizing life insurance as an investment vehicle, stating that the returns have historically been exceedingly low compared to mutual funds and other options. Regardless, the cash value of most whole life insurance contracts increases over time. Income tax issues exist because this is deemed income to the policyholder.
Consequences of Taxation
The good news for whole life policyholders is that their plan’s cash value growth is not subject to yearly income taxes. The building of cash value in a life insurance policy is tax-deferred, similar to retirement funds like 401(k) plans and IRAs. The IRS requires policyholders to pay taxes on this money until they cash out the policy.
Suppose a policyholder chooses to take the cash value of their whole life insurance policy. In that case, they must pay taxes on the difference between the cash value they get and the total premiums they paid during the policy’s term. For example, if they pay $100 per month for 20 years, or $24,000, and subsequently cash out the policy for $30,000, the taxable amount is $6,000.
Another advantage of whole life insurance is that the policyholder may borrow against the policy’s cash value in certain circumstances. The proceeds from this type of loan are often misunderstood to be taxable. Even when the loan amount surpasses the total premiums put into the policy, this is not the case. Taking out a loan reduces the policy’s cash value and, if applicable, the death benefit that is paid out.