The possibility of having to pay taxes on a life insurance policy is a question that could conceivably be answered in a number of ways. The details of all of the possibilities can be pretty confusing, but here is a basic breakdown of the possible scenarios of taxability and non-taxability when it comes to money received from a life insurance policy.
What is Safe for Taxation? When funds are received at the end result as originally intended by the policy, when the owner is deceased – the beneficiary will receive the full value of the policy completely tax free. When funds are obtained in the fashion it is not deemed as profiting by the government and therefore the sum, no matter how large or small in not taxable.
As long as your policy is kept ‘live’ and active, the cash growth of the policy is not taxable either. Not all life insurance policies experience enough cash growth beyond the original purchased value for this to be too much of a concern, but for those that do – any growth in cash value experienced over the life of the policy is safe from taxes as long as the policy remains in good standing.
What is considered Taxable? Any time any money received as a result of the policy can be considered as the owner profiting from the policy, the amount of money received is taxable by the government. This could include a few different scenarios including: when a policy is defaulted on, when a policy is cashed in, or when a policy is cancelled.
When you default on payments, cancel your policy or cash in your policy – the same result is effectively achieved. In most cases you’ll either get all of the premium payments you’ve made toward the policy back or you’ll get the current cash value of the policy depending upon the finer details of the policy in which you purchased. If you receive the cash value, and that cash value is greater than the premiums in which you had paid in, you have profited from the Life Insurance policy – so any money in excess of the amount of which you paid into the premium is therefore taxable.
If you have, at any point, borrowed against the cash value of your policy and complete repayment (including applicable interest) has not been made before you cash in or cancel your policy, the money owed will come directly out of the current cash value of the policy. This could potentially have an effect on whether or not you have to pay taxes on a portion of the money that you received as a result of the cancellation.
In short, if you continue to pay on your policy and you don’t borrow against the cash value you should be worry free in terms of taxation. If you decide to put an end to your life insurance policy for any reason, any money that you should receive that is greater than what you paid into the policy will be taxable and will therefore need to be reported to the IRS as income.
You should receive statements detailing the activity that has occurred regarding your life insurance policy, and perhaps even a statement informing you that potential tax information is enclosed. If you have any question in regard to the taxability of monies received from your life insurance policy as a result of cancellation, borrowing, or far any other reason you should address those issues with a qualified accountant before filing your tax return. Any accountant will be able to identify the taxability of any and all of your assets and help you submit your tax return in such a way that you can feel certain that nothing has been overlooked.