Everything You Need to Know About Taxation and Life Insurance

Most financial advisors encourage investors to diversify their portfolio so that if one venture goes down (the stock market, for instance), another one can compensate for it (real estate or bonds, perhaps). By doing so, they can ride out the storms in one area by having other assets that are stable or are going up in value.

And speaking of diversification, there is one investment option that everyone should seriously consider: life insurance. Aside from offering individuals financial protection from premature death, it also serves as a tool for accumulating wealth. This is possible through a savings program, which increases the cash value of the policy with every premium payment made and with every interest credited to the investor's account.

Of course, placing money in such an investment also entails tax liabilities. Thus, all insured individuals should be aware of their responsibilities. Doing so would help them avoid any problem with the revenue service and enable them to take advantage of exemptions and deductions.

How is insurance taxed?

Historically, policies have received favourable treatment from revenue service agencies worldwide. However, as insurance products have become more complicated and diverse, the line separating them from investment options has become blurred. Because of this, a mix of complex rules and exceptions now govern the taxation of indemnities. These laws and regulations vary among states and countries.

When is it taxed?

Taxes are generally levied against indemnities whenever there is an exchange of cash. During the term of any policy, there are a number of occasions wherein money does exchange hands. These include cash withdrawals and release of dividends or return of premiums.

It must be noted though that taxation will only be applicable in the aforementioned transactions if the amount received by the policyholders is in excess of the basis for non-taxable income and is higher than that of the premiums they have paid, respectively. Typically, those benefits paid out during one's lifetime and after death are tax-free. But the sale or surrender of policies before the holders' demise will be charged of tax.

To explore this topic further, here are the specific taxes charged against securities:

• Estate

Generally, these are not be deducted from the death benefit if the insured is not the beneficiary or possesses no interest or rights to an asset. Nevertheless, holders should be wary of this because policies with life plans are often bought with the intent of covering levies on estates, alerting the revenue service to keep an eye on such transactions.

• Income

These can be classified into four categories:

1. Death benefit - This a non-taxable income paid out upon the demise of the person insured.
2. Cash value - This refers to the amount offered to the policy owner upon the cancellation or termination of the contract. This is usually exempted from taxation, but it will be subjected to such under the following circumstances:
1. When it grows in excess to the cost basis (the original value of the policy).
2. When the amount withdrawn from it during the term of the cover is in excess of the insurance's original purchase price.
3. When the loan made against the indemnity is not paid on the set date.
3. Premiums - This is the amount paid by the insured to the underwriting company. It cannot be claimed as a tax deduction on personal income. However, exemption is allowed when a company pays the premiums for its employees and classifies it as part of their salaries. In such a case, the payments become deductions for the firm, but the workers are charged for it.
4. Dividends - These are considered as partial refunds to the premium and are, therefore, not levied. However, if the amount exceeds the cost basis it shall be taxed. The same happens if it accumulates interest as the latter not part of the policy and is classified as taxable income.
• Premiums

These are charged against general insurance premiums. Most long-term indemnities are exempted from these, such as reinsurance.

• Gift

If a person or a party who is not the policyholder supplies or pays a part of the entire cost of the premiums, those amounts paid may be considered as gifts and will be thus subject to taxation. This is, of course, applies only if the endowment is in excess of the allowable amount.

These are the most important things you need to know about taxation and insurance. If these topics are just too overwhelming for you, or if undertaking transactions related to these are just beyond your skills, never think twice to enlist the help of the experts. Tick Tax is just a phone call away.