Here are some final thoughts to consider when dealing with life insurance policies.
First, keep an eye out for the tax cost of employer-paid life insurance. The premium cost for the first $50,000 of life insurance coverage provided under group term life insurance plan does not have to be reported as income and is not taxed to you. However, amounts in excess of $50,000 paid by your employer will trigger a taxable income for the “economic value” of the coverage provided to you.
Along similar lines, be wary of the rules that apply if your company offers the option to purchase life insurance through a qualified retirement plan, and you make pretax contributions. Although pretax contributions offer certain income tax advantages, one tradeoff is that you’ll be required to pay tax on the economic value of the “pure life insurance” in the policy (i.e., the difference between the cash value and the death benefit) each year. Also, at death, the amount of the policy cash value that is paid out as part of the death benefit is treated as taxable income. All of that said, not many companies offer their employees the option to purchase life insurance through their qualified retirement plan.
Finally, remember that whoever receives the death benefit from your insurance policy usually does not have to pay federal or state income tax on those proceeds. So, if you die owning a life insurance policy with a $500,000 death benefit, your beneficiary under the policy will generally not have to pay income tax on the receipt of the $500,000. This is usually true regardless of whether you paid all of the premiums yourself, or whether your employer subsidized part or all of the premiums under a group insurance plan.
Life insurance is both a true necessity for financial planning and a very complicated amalgam of tax rules and tax-favored opportunities. It really is in your best interest to plan carefully alongside your trusted advisors, so you can ensure your family’s financial future is protected in the event of the unexpected.
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