Death benefits aren’t the only way life insurance may help your family’s finances.
Life insurance often seems pretty straightforward: You buy a policy and pay a premium to keep it active. Upon your death, your beneficiaries receive the income tax-free ‘death benefit’ amount.
However, you may wonder how life insurance can be used while you are still living. The ‘living benefits’ of life insurance can often be obtained using the cash value build-up of permanent life insurance policies. The main types of permanent life insurance include Whole Life, Universal Life and Variable Life.
Most (but not all) permanent life insurance accumulates cash value on a tax-deferred basis and can be a great component of your overall long-term financial plan. The cash value from permanent life insurance can be used for a variety of purposes including supplemental college or retirement funding.
When considering using the cash value of permanent life insurance, be sure to talk to your insurance agent about the fees and implications associated with these coverage options:
- Permanent insurance premiums are higher, compared to term insurance. This is because, in addition to the permanent death benefit protection it provides, part of the premium goes toward building the policy’s cash value. When you consider this, along with dramatic increases in term premiums later in life, permanent cash-value life insurance may be less expensive than term over your lifetime.
- Taking cash value out of the policy can reduce the death benefit paid to beneficiaries.Cash value can be taken out of the contract in the form of a withdrawal or a policy loan. Withdrawals—partial or full surrender—may incur early withdrawal penalties and may be subject to income tax. Loans may incur loan interest that could further diminish the death benefit amount payable to your beneficiaries if the loan is not paid back. The best way to determine how much can be taken out to avoid penalties or how much death benefit will be impacted is to ask your insurance agent for a ‘hypothetical illustration’ before planning to take any cash value out from your policy.
The information regarding access to cash value assumes the contract qualifies as life insurance under Internal Revenue Code (IRC) Section 7702. Most distributions are taxed on a first-in/first-out basis as long as the contract remains in force and meets the non-MEC (modified endowment contract) definitions of IRC Section 7702A. But if it is a MEC, then any distributions you take from your policy will generally be taxable and subject to a 10% penalty tax if you’re 59½ or younger. LAE-0293AO (12/11)
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