The second advantage of life insurance is that during the insureds lifetime, and while the policy is in force, all interest earned, dividends earned and/or capital gains realized on the policy investments are not subject to current income tax. All investment life insurance policies enjoy tax-deferral on this buildup and a possibility of total tax-exemption on investment returns within the contract, which occurs when the proceeds are disbursed as death benefits. In other words, if the policyowner never takes the gains from the policy, there will never be tax on the policys investment gains and the death online payday IN benefit will be paid to the beneficiaries tax-free.
The third income tax benefit of life insurance containing investment capital is that the amount of money which the insured recovers tax-free when surrendering a life insurance policy includes all the life insurance costs that the policy has charged during the time the policy has been in force. These costs are paid on a pretax basis even when a policy is surrendered.
The fourth income tax benefit of life insurance depends on whether or not the insured incurs taxation as a result of using the monies accumulated within the life insurance policy while it is still in force.
The insured could use these monies by withdrawing them, borrowing them from the insurance company or pledging the policy as collateral for a loan.
The tax code permits tax-free use of these funds up to certain prescribed levels. Any insured should always obtain competent tax advice before accessing insurance policy funds in order to confirm that the use will be permitted free from tax.
Before concluding our discussion of life insurance, we will turn to another product frequently sold by life insurance companies: Annuities. An annuity is an investment contract between an individual and the insurance company. The individual receives a return on his or her investment that supplements the individuals contribution. At some point in time, the individual can choose to annuitize the investment to provide income for a specified period of time in the persons lifetime.
The earnings on an annuity can grow without being diminished by taxes. These earnings are not taxable until the individual withdraws them, and they are spread out over a number of years. When an individual begins receiving income from an annuity, only part of the income is taxable because the individual receives both interest and a partial return of the invested principal.
To make the best use of the positive tax advantages of an annuity, individuals also must be aware of potential tax problems. The IRS imposes a penalty on withdrawals unless an individual is over age 59 1/2 when withdrawing money from the annuity or cashing it in. There is a 10 percent penalty on any earnings withdrawn, along with the tax owed on the withdrawal. These charges are in addition to any insurance company fees that might be imposed upon the withdrawal.
Customers should be advised to approach the purchase of an annuity with the expectation that they will not draw on it until they are older than age 59 1/2. To fully exploit the tax advantages, the individual should plan on holding the annuity for many years so that the earnings can grow without current taxation. No matter what the tax advantages of an annuity are, the individual still must pay close attention to the rate of return on the investment.
Types of Annuities
Qualified annuities are purchased with funds generated from qualified retirement plans. Contributions to qualified plans generally are not subject to current taxation when they are contributed to the plan. Examples of qualified retirement plans include Individual Retirement Accounts (IRAs), IRAs that qualify for an income tax deduction are qualified plans as are Simplified Employee Pension Plans (SEPs), 401(k) plans, profit-sharing plans and pension plans.