Tax Free Life Insurance Withdrawal
Reader Question
I need to borrow against my Life Insurance but I was told I would have to pay tax on any withdrawals. If this is true at what tax rate would I be assessed?
Sincerely, Alfred in Oklahoma
Thank you Alfred for your question. If you have a variable and traditional whole life policies, you may not be allowed to withdraw from your cash value. Examine you policy to assure any withdrawal you make will be tax free up to the amount of premiums you have paid into the policy, minus any prior dividends paid or previous withdrawals. What you have paid in you already paid income tax on, therefore they won’t be taxed again when you withdraw them from the policy.
You will have to pay taxes on earnings above your cash basis of the policy. Let me explain, if you have a cash value life insurance policy with a cash value of $18,000. If your basis in the policy is $12,000, you can withdraw this amount without any tax penalty. Any amount above this you will have to pay income tax at ordinary income rates, not at capital gains rates.
Surrender charges may apply when you make a withdrawal. A smart way to avoid this is to take a policy loan from the insurance company, using the cash value in the policy as collateral. If you repay the loan the amount you borrow is generally not treated as taxable income, and there are no surrender charges. You will have to pay interest on the loan, which is not tax deductible.
Category: Reader Questions
