When is the Cash Value of Whole Life Insurance Taxable?

iQuanti: Whole life insurance provides lifelong coverage, but its cash value growth component can also help you build wealth. Part of each premium goes into this component, which grows tax-deferred at a guaranteed rate.

However, you may owe taxes on your cash value under certain circumstances. Knowing these can help you minimize your tax liability and keep more of your money. This article will explore when whole life insurance is taxable and when it isn't to help you minimize your tax bill.

When cash value is taxable

The cash value of your whole life policy is generally taxable in these two situations:  

Withdrawals beyond your policy basis

When your cash value grows large enough, you can withdraw from it at any time. Withdrawing just your basis, or the amount of premiums you paid into the policy that went toward cash value, won't trigger taxes.

However, if you withdraw any interest earned above that amount, you may owe taxes on those earnings. Your life insurer will most likely provide you with documents showing which portion of your withdrawals are considered taxable earnings.

Surrendering your policy

If you no longer need your policy, you can surrender it. This eliminates your coverage but lets you receive your cash value, minus surrender charges. Like withdrawals, you may owe taxes on any interest earnings above your policy basis. 

When cash value is not taxable

Fortunately, there are ways to use your cash value without owing taxes on it. Here are some situations where you don't have to worry about tax consequences:

Annual cash value growth within the account

Cash value grows tax-deferred at a fixed interest rate. That means when you earn interest, it isn't taxed as long as it stays in the account. This lets you take advantage of compounding, where your interest earns more interest. For example, if you earn $100 in interest, that becomes part of your cash value, giving you a larger balance to earn interest on.

Borrowing from cash value 

When your cash value grows enough, your whole life insurance lets you borrow against it at a great rate - often with no credit check or due date. Borrowing money from your cash value generally isn't taxable if the policy remains active and offers policyholders a tax-free way to access funds.

The exception is if your policy terminates while the loan is outstanding. You may owe taxes on the loan proceeds you received in this case. Policies can lapse if the loan balance grows larger than the cash value, so make sure the loan doesn't get too big.

The bottom line

Whole life insurance doesn't just let you protect your loved ones. It offers you a tax-advantaged way to build wealth through your cash value account. However, you have to access your wealth the right way to minimize taxes. If you withdraw or surrender your policy, be prepared to set aside some of your proceeds for taxes.

To avoid owing taxes, let the cash value grow tax-deferred as long as possible. Then, borrow against it if needed and make sure your loan balance doesn't get larger than your cash value. Doing this will help you maximize your money while minimizing your tax liability.

Source: iQuanti, Inc.