Whole Life Insurance: Capital Gains Or Smart Investment?

Whole life insurance is a type of permanent life insurance that includes an investment component. The cash value of a whole life insurance policy is not taxed while it's growing, which is known as being tax-deferred. This means that interest made on the cash value is applied to a higher amount, as it's not reduced by taxes each year. However, if you withdraw more than you've paid into the policy, the amount exceeding the sum of your premium payments may be subject to income tax. If you surrender your policy or it lapses, you may also need to pay taxes on any money that came from interest or investment gains.

Whole life insurance cash value withdrawals

Permanent life insurance policies, such as whole life insurance, are designed to provide coverage for your entire life and can build cash value, which can be used for future expenses. This cash value can be accessed through four methods: surrender, withdrawal, loans, and using the cash value to pay your life insurance premium.

Surrender

If you decide to cancel your whole life insurance policy, you can take the surrender value cash payment. However, this option comes with several disadvantages. Firstly, you will no longer have life insurance coverage. Secondly, the cash you receive will be reduced by any fees and charges. Surrendering a policy before retirement age should be a last resort, especially if you don't have alternative life insurance in place.

Withdrawal

Withdrawing cash from your whole life insurance policy is often a viable option, and the money is usually not subject to income taxes as long as the withdrawal amount does not exceed the sum of the premiums you have paid into the policy. However, there are a few potential drawbacks to consider. Withdrawing cash will likely result in a reduction in your death benefit, and this reduction may be greater than the amount withdrawn, depending on the specific terms of your policy. It is important to discuss the implications of withdrawing money with your agent or life insurance company to fully understand how it will affect your coverage.

Loans

You can typically borrow money through your whole life insurance policy by taking out a loan from the insurer, with your policy serving as collateral. These policy loans offer several advantages, including no loan application or credit check, and competitive interest rates compared to personal loans or home equity loans. Additionally, your credit rating does not impact your interest rate. However, it is important to note that any unpaid loan balance will typically be deducted from your death benefit.

Using Cash Value to Pay Premiums

Another option is to use the cash value that has accumulated in your whole life insurance policy to pay part or all of your policy premiums. This approach can be particularly beneficial for older policyholders who wish to continue their life insurance coverage while using their retirement income for living expenses.

It is important to carefully consider the advantages and disadvantages of each option before making a decision. Additionally, it is recommended to consult with a financial professional to understand the specific terms and implications of your whole life insurance policy.

Whole life insurance dividends

Dividends from whole life insurance policies are not subject to income tax. They are treated as a distribution from the contract and taxed similarly to other types of distributions. Dividends are distributed income-tax-free until the taxpayer's investment in the contract has been reduced to zero. This is because the insurance companies generated the gains from their policyholders, so the dividend payments are treated as refunds for overpayment of the premium.

Dividends from participating whole life insurance policies are based on the performance of the company's financials, including interest rates, investment returns, and new policies sold. The amount of the dividend is tied to the price of premiums paid by the policyholder. The higher the dividend, the more expensive the policy.

Policyowners have several options for receiving dividends, including:

• Cash or check
• Premium deductions
• Additional insurance
• Savings account

While dividends are not guaranteed, most mutual insurance carriers strive to pay them consistently to eligible participating whole life policyowners.

Whole life insurance loans

Whole life insurance is a type of permanent life insurance that combines life insurance with an investment component. It is characterised by level premiums and a savings component. As a result, whole life insurance policies accumulate cash value over time, which can be withdrawn or borrowed against.

Borrowing against a whole life insurance policy

Borrowing against a whole life insurance policy can be a good option for those looking for a loan with low-interest rates, flexible repayment terms, and no credit check. The funds you borrow are tax-free, but there are typically interest payments. However, if you do not repay the loan (and interest), the death benefit will decrease, and if the interest creeps up and you owe more than you have in your policy, it will lapse. If the policy lapses, the cash you took out may be treated as income by the IRS, and you may owe taxes on it.

As cash value builds in a whole life insurance policy, policyholders can borrow against the accumulated funds. Many policies start accruing cash value in two to five years and will likely be enough to borrow against in about 10 years.

The amount of cash value you can take out of your whole life insurance policy depends on the rules of the insurance company that holds your policy. Usually, if there is accumulated cash value in your policy, you can borrow from it, make withdrawals, or surrender your policy and remove your cash. You can usually borrow up to a certain percentage of the cash value in your whole life insurance policy. The insurance company holding your policy dictates the exact amount you can borrow.

It can take anywhere from one day to 15 days to receive funds from a life insurance loan, depending on the insurance company.

Should you pay back a whole life insurance loan?

The money you are allowed to borrow from your whole life insurance policy is yours. However, if you don't pay it back, the policy will eventually lapse. When this happens, your beneficiaries lose their inheritance from the life insurance, and you lose the opportunity to use the money again in the future. In addition, if you don't pay the loan back and the amount you borrow reaches the amount of cash value (or exceeds it), you may find yourself owing taxes.

Whole life insurance surrender

Surrendering a whole life insurance policy means cancelling the policy and receiving a lump sum payout, known as the cash surrender value, in exchange for ending the coverage. This is different from cashing out a policy, which can be done through a withdrawal or a policy loan without surrendering the policy.

The cash surrender value is the amount of money you receive from the policy when you decide to surrender it. It is generally less than the cash value of the policy, as surrender fees and outstanding loan balances are deducted. If the cash surrender value is higher than the amount you've paid in through premiums, you will need to pay income taxes on the difference.

There are several reasons why you might want to surrender a whole life insurance policy:

• Cost: If you can no longer afford the premiums, surrendering the policy will give you access to the cash surrender value and relieve you of the monthly premium payments.
• Cash needs: Surrendering the policy will provide a lump sum of cash if you need money quickly. However, it's worth considering other ways to access your cash value, such as a policy loan, without giving up coverage.
• Better coverage or price: You may find a new policy that offers better coverage or a lower price, making it more suitable for your needs.
• No longer needed: If no one relies on you financially, you may not need life insurance coverage anymore, and it may not make financial sense to keep the policy.

When deciding whether to surrender your whole life insurance policy, it's important to consider the potential tax implications and the impact on your long-term estate planning and goals. Surrendering the policy will result in the loss of the death benefit for your beneficiaries, so it's crucial to carefully weigh your options before making a decision.

Whole life insurance taxation

Whole life insurance is a form of permanent life insurance that provides coverage for your entire life, as long as you keep your payments up to date. It also has a cash value component that is money you can use during your lifetime. This cash value is not taxed while it's growing, which is known as being "tax-deferred". This means that your money grows faster because it's not being reduced by taxes each year.

Interest generated from whole life insurance policies is also not taxed until the policy is cashed out. When you do cash out, you will pay tax on the difference between the cash value received and the total amount paid in premiums during the time the policy was in force.

You can take out a loan against the cash value of a whole life insurance policy, and this is not usually considered taxable income. However, if the policy terminates before the loan is repaid, you may be taxed on the amount of the loan that exceeds your policy basis (the total amount you've paid in premiums).

If you surrender a whole life insurance policy, you will be taxed on any investment gains. For example, if you've paid $38,000 in premiums and the cash value of the policy is $45,000, you will be taxed on the $7,000 difference.

Dividends from whole life insurance are generally not taxable, but interest earned on those dividends is.

In summary, whole life insurance offers several tax advantages, but tax regulations can be complicated, and it's important to consult with a financial professional or tax advisor for guidance.

Frequently asked questions