Life Insurance and Retirement Planning: Tax Issues

Life Insurance and Retirement Planning: Tax IssuesTax-Deferred Growth

The Tax Court has held that cash values are not constructively received by a taxpayer when he or she could not reach them without surrendering the policy. The necessity of surrendering the policy constituted a substantial limitation or restriction on their receipt (Theodore H. Cohen, 39 TC 1055, acq. 1964-1 CB-4).

FIFO Taxation of Withdrawals

Assuming a single premium or periodic premium life insurance contract satisfies the conditions of the“seven-pay test”of IRC Sec. 7702A(b) (e.,not a modified endowment contract), living benefits received from the contract are taxed under the“cost recovery rule,”regardless of when the contract was entered into or when premiums were paid. This means that such amounts received from the contract are included in gross income only to the extent they exceed the investment in the contract (IRC Sec. 7702).

Policy Loans Are Income Tax Free

Policy loans from life insurance contracts are not treated as distributions, assuming the policy qualifies as life insurance under IRC Sec. 7702 and is not considered a modified endowment contract. Upon policy lapse or surrender, the outstanding loan balance is automatically repaid from policy cash values. This may, however,
cause the recognition of taxable income. At death, the death benefit will automatically be reduced by the amount of the outstanding loan, an action that does not cause the recognition of taxable income.

Income-Tax-Free Death Benefit

As a general rule, death benefits are excludable from the beneficiary’s gross income (IRC Sec.101(a)(1)).

Income-Tax-Free Accelerated Death Benefits

Depending on current tax law, receiving an accelerated death benefit disbursement may trigger a “taxable event” for the insured. Consult a tax professional about the possible tax implications of accepting a disbursement of accelerated death benefit funds.

Published by The Virtual Assistant; © 2012 VSA, LP


About The Author

Richard Eddy

Founder of and Cona Financial Group Richard Eddy has been assisting clients with their life insurance needs since 2005. He is an expert helping people find the right policy to fit their specific situation. In addition to insurance planning, he is also experienced in a wide range of financial planning topics including investment and portfolio analysis, tax planning, retirement planning and estate preservation strategies. You can call Richard toll-free at (877) 883-3561.