Life insurers generate profits in at least two ways. First, is that not all individuals who entered into a contract of insurance qualify for recovery and thus the closing cost as well as the premiums paid remain for the account of the insurer. Second, the money collected by the insurer is loaned or invested in different business ventures in order to create profit. Remember an insurer usually collects monthly premium\ms hence it is not only the money on hand that they can invest but the certainty of a specific collection amount. With profits come taxes and this is what this article is all about, taxes applicable to life insurance policies.
Power of Taxation
The inherent right of the state to collect funds on any action of its citizen. The relationship between life insurance and taxation is a bit tricky to explain. On one hand life insurance can provide a certain degree of benefit or shielding and on the other taking out life insurance can prove to have certain tax consequences.Benefit: Lump Sum Payments are Not Taxable
Any lump sum payment by an insurer to an insured is tax free. A possible exception to this is if the deceased originated the policy and the named beneficiary is the same or the estate. However, if the beneficiary is the spouse and/or children then taking out a life insurance policy to convert a taxable part of the estate into tax free lump sum payment/payments is a viable option. By way of example, the life insurance policy of Mr. A provides that upon his death the entire award for the life insurance policy will be given in lump sum to his beloved wife.
Drawback: Installment Payment are Taxable
In some cases the named insured wants to have the moneys given ion installment to serve as a regular allowance for the family for a specified period of time after his or her death. The problem with this arrangement is that these installment payments will be taxable. However to be more specific compute the percentage of installments that is taxed and not taxed. The formula is the total amount to be received divided by the number of years of payment to be received on installment. Any remainder will be considered interest and is taxable as income. For example, if the life insurance policy of Mr. A provides that upon his death his wife will receive $1,000 monthly allowance for 10 years then each installment is taxable.Benefit: Policy of Mutual Insurance Maybe Taxable
A policy of mutual insurance that allows the originator to earn dividends on a regular basis is not taxable as a general rule. By way of exception, any dividend installment received over and above the premium payments made is taxable as to the difference. This scenario is highly unlikely but still possible. Take note that these dividends are dividends from your life insurance policy not dividends on shares of stocks in a corporation which is always taxable. For example, the policy of life insurance requires regular premium payments of $100. If the insurer gives out dividends on a regular basis and the amount given for one dividend payment exceeds $100 then the excess is taxable.
