Whole life insurance provides several key benefits, including permanent coverage, a generous death benefit, and cash value that accumulates over time. A policy owner can tap into their cash value, but it could generate tax consequences, making this a costly asset to use.
The cash value of whole life insurance grows tax-deferred, much like a traditional IRA or a 401K retirement account. As a policy’s cash value climbs, the policyholder does not pay income taxes – unless they cash it out. Tax deferral makes a significant impact as it allows the value to grow over time. Life insurance is a wonderful tool for tax-conscious individuals, as death benefit payouts are not taxable income.
Accessing the cash value of a whole life policy, however, could trigger a tax bill if you withdraw cash over and above the value of the premiums you’ve paid in. The amount exceeding what you’ve paid in premiums is considered earnings — and is taxable income upon withdrawal. This could mean that you might need to take out more than planned to cover your tax liability.
Fortunately, there’s a tax-efficient alternative that allows you to access the cash value of your policy without triggering a tax bill: a cash value loan. Because it is secured by the cash value of your whole life insurance policy, a cash value loan can provide you with liquidity without the tax implications of a direct withdrawal. As long as the policy is in force, you will not be taxed on the funds you borrow. While it remains outstanding, a loan will reduce the policy’s cash value, and if applicable, its death benefit.
Business owners can optimize their tax-efficiency by booking their cash value loan directly to their business. This strategy creates potential tax advantages, including potentially allowing you to deduct the interest as a business expense. Make sure to discuss this with your accountant or a tax professional.
