Most people are not aware that when they purchase a life insurance policy to protect their loved ones in most cases the proceeds will be tax free. This is especially true for Term Life insurance policies. All of the life insurance benefits that are distributed tax free.
Term life insurance benefits are tax free because you will not accrue any cash value with this type of policy. If you purchase a whole life, universal or variable life insurance policy there are some restrictions. For instance, any amount of money that you contributed, gained interest on, or invested that is more than the death benefit will be taxed. So let’s say that your beneficiary received $150,000 in proceeds from your life insurance carrier. The death benefit was $100,000 but you had a cash value of $150,000. The $50,000 would be taxed because it is considered taxable income.
Many times when people begin their estate planning their advisor or lawyer will recommend life insurance as a tool to transfer family wealth without having to pay taxes. Some people with larger estates will create a life trust to help them transfer wealth to their families. Instead of them listing a family member as a beneficiary they will instead name a trust as the beneficiary which is often referred to as a life trust. The main objective in creating this is to pay for estate taxes or as inheritance to an heir.
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