Question About Life Insurance And Income Tax (US Residents Only)

10 years ago

Life insurance proceeds, including cash value...are not taxable. They are not tax deductible, but you pay no income tax on your payout. It's considered a return of your own money.

Life insurance may be included as part of an estate (I'm not 100% sure about this) but there is no tax on life insurance proceeds. The government gets none of this.

And, unless you are very wealthy, your estate won't be large enough to be taxed.

It's easy to verify these answers online at any life insurance company website.

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seasoned

10 years ago

Originally Posted by Steven Wagenheim

Maybe somebody here can answer this because I can't afford a lawyer right now.

I understand that if I die and my wife gets my life insurance payoff, THAT is taxable as part of the estate tax.

However, what if I cash in my life insurance policy for the value of the money I actually put into it?

My thinking is this.

If I paid $10,000 into my life insurance (money that I've already paid income tax on because life insurance premium payments are NOT tax deductible) and I then get that $10,000 back when I cash in my policy, since I already paid taxes on that money, I shouldn't have to pay taxes on it when getting it back since I'm not earning any additional income.

Can somebody confirm this or is the govt actually going to put the screws to me?

Because somehow paying taxes on money I already paid taxes on seems wrong on so many levels.

I can't speak for other places, but the OFFICIAL statement of the California Insurance Commissioner is "Life insurance cash value is 'return of excess premium paid'"!

Steve

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Steven Wagenheim

10 years ago

Originally Posted by seasoned

I can't speak for other places, but the OFFICIAL statement of the California Insurance Commissioner is "Life insurance cash value is 'return of excess premium paid'"!

Steve

Hey Steve, what does that mean in English? LOL

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joseph7384 10 years ago

Originally Posted by Steven Wagenheim

Hey Steve, what does that mean in English? LOL

In other words, you overpaid so we are returning what is owed to you.
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seasoned

10 years ago

Originally Posted by Steven Wagenheim

Hey Steve, what does that mean in English? LOL

Joseph is right! FOR EXAMPLE, to be funny, and test something out, I wet to an alstate agent, and asked what life insurance would cost. HE gave me a write up selling me a GARBAGE product. It goes by LOTS of names:

CASH VALUE
UNIVERSAL LIFE
ETC....

The funny thing is it REALLY doesn't exist! Go to a place and check it out! They would charge me over $1000/month, but INSIDE the packet they give you, which includes the "projection", they state that the insurance is REALLY one year renewable TERM, and they have a projection for THAT! THAT costs less than say $20/month. Your "cash value" is the difference between the two.

I don't really know HOW they do so well with term, but it DOES do what most originally buy whole life for. Of course TERM only pays when the person dies in a legitimate way. They may not pay in the first 2 years, or pay for a suicide, etc... They also don't pay if the person isn't current on payments.

But you are getting money you ALREADY paid tax on, so you don't have to pay again.

Steve

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Steven Wagenheim

10 years ago

Okay, just got off the phone with the insurance company. The money that I'll be getting if I cash the policy in is not just what I put into it. It will also include any dividends earned which I will have to pay taxes on.

Anyway, I've gone ahead with the process. They're going to send me all the paperwork and the whole process is going to take about 3 weeks between their mailing, my return mailing and their processing of the claim.

But this will really help get me through a good part of next year while I work on rebuilding my business.

Anyway, thanks for all the responses guys. If you think of anything else I should ask them before I go ahead with filling out the paperwork, let me know.

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seasoned

10 years ago

Originally Posted by Steven Wagenheim

Okay, just got off the phone with the insurance company. The money that I'll be getting if I cash the policy in is not just what I put into it. It will also include any dividends earned which I will have to pay taxes on.

Anyway, I've gone ahead with the process. They're going to send me all the paperwork and the whole process is going to take about 3 weeks between their mailing, my return mailing and their processing of the claim.

But this will really help get me through a good part of next year while I work on rebuilding my business.

Anyway, thanks for all the responses guys. If you think of anything else I should ask them before I go ahead with filling out the paperwork, let me know.

If true, you made history! Then agin, maybe the NJ laws are just WEIRD!

Steve

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Kay King 10 years ago

Seasoned - it's not weird. You pay taxes only when you received more in cashing in a policy than you paid in premiums over the years.

Is Cash Surrender Value Of Insurance Taxed? | Bankrate.com
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Claude Whitacre

10 years ago

Originally Posted by Steven Wagenheim

Okay, just got off the phone with the insurance company. The money that I'll be getting if I cash the policy in is not just what I put into it. It will also include any dividends earned which I will have to pay taxes on.

Anyway, I've gone ahead with the process. They're going to send me all the paperwork and the whole process is going to take about 3 weeks between their mailing, my return mailing and their processing of the claim.

But this will really help get me through a good part of next year while I work on rebuilding my business.

Anyway, thanks for all the responses guys. If you think of anything else I should ask them before I go ahead with filling out the paperwork, let me know.

Don't cash in the policy. Borrow the cash value. It's the same amount of money, but your insurance doesn't go away. In fact, sometimes the cash value increases faster than the premium....so the contract could stay in force forever..until you die.

Borrowed money isn't taxable. Really. It's in your best interests to borrow the cash value, instead of cashing the policy in.

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kenmichaels

10 years ago

Originally Posted by Claude Whitacre

Don't cash in the policy. Borrow the cash value. It's the same amount of money, but your insurance doesn't go away. In fact, sometimes the cash value increases faster than the premium....so the contract could stay in force forever..until you die.

Borrowed money isn't taxable. Really. It's in your best interests to borrow the cash value, instead of cashing the policy in.

You read my mind.

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Steven Wagenheim

10 years ago

Originally Posted by Claude Whitacre

Don't cash in the policy. Borrow the cash value. It's the same amount of money, but your insurance doesn't go away. In fact, sometimes the cash value increases faster than the premium....so the contract could stay in force forever..until you die.

Borrowed money isn't taxable. Really. It's in your best interests to borrow the cash value, instead of cashing the policy in.

We actually discussed this as an option. For whatever reason, what I can borrow is only one third of what I get if I cash in the policy. I don't know why (I really didn't understand a lot of what she was saying) but that much I got. I can borrow $17,000 right now. If I cash it in, I get $48,000 right now. I'm assuming the extra $31,000 is the dividends earned.

If this was a question of money we needed for later in life, or after I'm gone, then of course it's a no brainer. I just keep rolling the policy over. We're paying about $600 a year now and getting about $2,300 in dividends for a net of about $1,700.

But our "later on after I'm gone" is already taken care of. This policy was supposed to be one of those "7 years payments...make a million dollars in insurance payouts at death" things but when interest rates plunged from 18% during the Carter administration to the 1 or 2% they are today, that pretty much shot that dream to hell making my insurance not really worth all that much. In fact, I'll only get back about double what I'm worth now upon death if I died today. I'd rather take the money and invest it in something that can maybe give me a little better return than $1,700 a year. By the time I'm gone, my wife will have her pension, a tax shelter and money from another source. In short, she'll be more than taken care of.

I, on the other hand, am up the creek if she should pass away. This money will help me get back on my feet and possibly make it so that I can take care of myself if the day should come.

Plus, it will also give my wife some peace of mind with all the home repairs that are creeping up on us within the next 5 years or so. This cushion will let her breathe a little easier should something unforeseen happen.

In short, the policy never did what it was supposed to do and after 30 years of paying it, I can see that continuing to do so is pointless.

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Claude Whitacre

10 years ago

Originally Posted by seasoned

Of course TERM only pays when the person dies in a legitimate way. They may not pay in the first 2 years, or pay for a suicide, etc... They also don't pay if the person isn't current on payments.

Steve; All life insurance is the same, in that the first two years, they can contest the claim, and suicides aren't covered. Neither are deaths while committing a felony. But in nearly every case, they pay the claim.

It doesn't matter if it's term or whole life. It's the way insurance law works.

A few companies, it's only one year. It's to prevent people buying insurance to commit suicide. And also it gives the company the right to contest the claim, if there were any falsehoods in the application....like not disclosing hat you have cancer.

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kenmichaels

10 years ago

If you were a family member, I would suggest a cool down period before pulling the trigger.

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Steven Wagenheim

10 years ago

Okay, just got off the phone with the insurance company for the second time and got all my options down in writing.

Here they are.

1) Cash in the policy for $47,835. A portion of that will be taxable. Don't know how much yet. Probably about $25,000 based on actual premiums we paid. At 22% tax rate, that's about $5,200 in taxes leaving us with about $42,635 and no insurance.

2) Withdraw the dividends earned. That comes out to $17,000. That will reduce my death benefit from $140,000 to $100,000.

3) Borrow the entire cash value of $47,835. Current interest rate on that is 5% variable. Interest comes out to $2,200 yearly. Premium due in addition to that is $2,404 yearly. Dividends earned currently (and this is why it makes no sense to do this) are only $1,799.

So I'm not earning enough in dividends to pay for the loan. In short, over time, the interest and money we'll owe will become substantial. After spending 25 years to finally pay off our credit cards and mortgage, there is no way my wife would agree to go into debt again. So option 3 is totally out even if I wanted to do it.

So it comes down to options 1 or 2. I will discuss those with her tonight and see which one she wants. I'll do whatever she says. I know my wife. We'll be going ahead and cashing in this policy. It has been a disappointment since 1991 when we were told that we had to keep paying after the 7th year because "Interest rates didn't keep up with expectations." And we've been paying this policy now for 30 years. At $2,404 a year, we could have had $72,000 in the bank already or invested in something else.

Sometimes you do something and it just doesn't work out the way you expected. This is just one of those things.

For the record, these policies came under attack by many people when the interest rates plummeted and people weren't getting what they expected from them, resulting in a number of lawsuits against Prudential. Had I known, I probably would have done the same, But that's water under the bridge now.

Time to move on.

Also, we have like 3 other policies with them that ARE giving us what we expected out of them. Those we are keeping and will more than take care of us,

But this turkey has to go. At $1,500 income this year, I can use the money.

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Kay King

10 years ago

And we've been paying this policy now for 30 years. At $2,404 a year, we could have had $72,000 in the bank already or invested in something else.

That's the wrong way to look at it. This was primarily insurance. At any time during those 30 years - a death would have yielded a lot more than $72k.

You've had insurance coverage for 30 years - AND still have cash value. I wouldn't call that a turkey.

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Steven Wagenheim

10 years ago

Originally Posted by Kay King

That's the wrong way to look at it. This was primarily insurance. At any time during those 30 years - a death would have yielded a lot more than $72k.

You've had insurance coverage for 30 years - AND still have cash value. I wouldn't call that a turkey.

In comparison to the million dollars we were "promised" after 7 years, yeah, it really is.

And you're right, had I passed on early, it would have been worth it. I think we had $100,000 right from the start minimum. But now, we're getting more than that from the "garbage" policies we have, my wife's tax shelter, pension and other source that will probably come around in the next 5 to 10 years.

Later on is when we'll be fine. Now, while I'm not earning much to speak of, is when this will really come in handy.

If the extra $100,000 is going to mean the difference between my wife being out on the street or not, then we have a more serious problem than this policy can possibly solve.

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Claude Whitacre

10 years ago

Originally Posted by kenmichaels

If you were a family member, I would suggest a cool down period before pulling the trigger.

Me too.

Steven; Convert the dividends into "Paid up additions". They will have instant cash value that you can borrow.

You're getting a phenomenal return on your money right now. Please don't take it out until you really need it.

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Steven Wagenheim

10 years ago

Just a quick update and then I have to go.

My wife and I discussed this and we've decided to just let the policy keep going as it is. She's going to pay the $605 premium for the next year and that's it.

If the day comes when we really need the money (not when it would be nice to have) then we'll revisit this issue and do something then.

Thank you for all your advice. For once I listened, weighed all my options, discussed it with my wife, and probably did the right thing.

In the meantime, I'm making some money now and somehow I'll figure out a way to continue paying the few personal expenses that I have.

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bizgrower

10 years ago

Originally Posted by Steven Wagenheim

Just a quick update and then I have to go.

My wife and I discussed this and we've decided to just let the policy keep going as it is. She's going to pay the $605 premium for the next year and that's it.

If the day comes when we really need the money (not when it would be nice to have) then we'll revisit this issue and do something then.

Thank you for all your advice. For once I listened, weighed all my options, discussed it with my wife, and probably did the right thing.

In the meantime, I'm making some money now and somehow I'll figure out a way to continue paying the few personal expenses that I have.

This sounds best.

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bizgrower

10 years ago

I know that you said #3 is out, but I think those loans are a line of credit you can reuse, or there is that option. And, you might look at the tax consequences for advantages. Also, from what you wrote or I'm not reading or doing the maths correctly, the dividends are almost making the payments.

People use these loans in place of other major purchase loans because of the better interest rate and still having the asset. It's the start of the "Bank on Yourself" or "Become Your Own Bank" concept.

I'd get a free consult with a Certified Financial Planner if I were in your shoes. Wife might think differently if she hears from somebody else. Pretty sure you are not going to rack up credit as you did in the past.

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Steven Wagenheim

10 years ago

Originally Posted by bizgrower

I know that you said #3 is out, but I think there is a line of credit option and you might look at the tax consequences for advantages. Also, from what you wrote or I'm not reading or doing the maths correctly, the dividends are almost making the payments.

The dividends are $600 short of the payments. Now tack on another $2,200 a year interest.

My wife would sooner shoot me than let me borrow against this policy.

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Kay King 10 years ago

I would choose #2 unless I NEEDED the $48k now.

Would not choose #3 unless I was in position to make the payments on such a loan and the loan was for a specific project (home addition, etc).

I would not choose #1 unless I truly needed that much money now.

Sit down with your wife and talk it through. It your policy so do what you want. If you take out $47k to "have it in case it's needed" you'll need to earn enough interest on it to match the dividend it could earn plus the extra taxes paid. That might be more than you get today in interest.

My suggestion is you discuss it tonight - and then wait a week or so before making a decision to give you both time to think and digest the information.
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bizgrower

10 years ago

Originally Posted by Steven Wagenheim

The dividends are $600 short of the payments. Now tack on another $2,200 a year interest.

My wife would sooner shoot me than let me borrow against this policy.

I modified my post, so please look again - esp about talking to a Certified Financial Planner.
Especially at this stage of life.

One other thought, you don't have to borrow or establish a line of credit at the full amount.

Now you can get back to work. LOL

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Dan Riffle

10 years ago

Steve, I mean what I'm about to say in the nicest way possible: get back to work.

I see this thread dipping into the usual territory: people are going to give you answers different than your own and you're going to waste time defending yourself.

You asked your question. You got answers. You have a strategy. Move on.

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waterotter

10 years ago

Wise choice, Steven. Now you have funds for a "rainy day" should you desperately need it.

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Question About Life Insurance And Income Tax (US Residents Only)

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