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Exploring Tax Benefits Related to Life Insurance and Annuities

Monday, April 15th is fast approaching. Before we know it another tax season will have come and gone. With many individuals now looking forward to receiving their returns or keeping new approaches for the taxes due after 2019 top of mind, it seems an ideal time to examine some of the tax advantages particular to life insurance policies and annuities.

Life Insurance

Estate Taxes Relief – If a policyholder suspects that their estate may be subject to estate taxes after they die life insurance can provide one possible solution to smooth the transition. A life insurance policy may be structured to provide cash in order to pay estate taxes and protect family-owned businesses, real estate, or other valuable possessions.

Tax-Free Dividends – The dividends on eligible life insurance policies are considered a return of policy premiums and in many cases are tax-free and do not have to be reported on the policyholders’ tax return. As long as the dividends don’t exceed the net amount of premium that has already been paid into the policy, dividends may serve as a tax-free resource. Additionally, upon death of the insured, the cash value is absorbed by the insurance company and the death benefit is paid out to the beneficiary free of income tax.

Irrevocable Life Insurance Trusts – An Irrevocable Life Insurance Trust (ILIT) is often used to set aside assets or certain purposes, which may include reducing or avoiding taxable actions. If the ILIT is structured properly, death benefits paid to the trust are free from inclusion in the gross estate of the insured and are not taxable in the estate such as they would be if they were paid to an individual.


Tax-Deferred Growth – Annuities are free of federal, state, and local taxes during their accumulation phase, allowing contract holders to put off taxes and maximize the contract’s growth.

Withdraw Timing – Annuities can provide some contract holders control over when and how they pay taxes on the funds within the policy. Contract holders may decide to withdraw a lump sum distribution at any time but will be required to pay taxes on withdraws until all the policy’s earnings have been withdrawn. However, contract holders may also choose a lifetime annuity option with payments which are taxed according to an exclusion ratio, meaning that each payment will consist of a portion of the tax-free principal and a portion of income-taxable interest. It is important to note that a penalty may apply if distributions are taken before the age of 59 ½.

Avoiding Mandatory Distribution Age – Unlike other retirement vehicles, annuities have no mandatory distribution age. This allows contract holders to potentially keep their annuity growing well past age 70 ½ so retirees with the necessary financial planning in place can generate a large account value that won’t diminish. This value may also be passed on as a death benefit to their beneficiaries (also subject to income taxes, but generally probate free).


Tax Advatages of Life Insurance and Annuities, Insurance News Net

Using Tax Advantages of Life Insurance in Your Financial Plan, Nerd Wallet

When Is It a Good Idea to Use ILIT Trust? , Investopedia







The information contained herein is for general information purposes only. Simplicity Life is not to be held responsible for the accuracy of this information. Neither Simplicity Life nor its employees provide tax or legal advice. As with all matters of a tax or legal nature, your clients should consult their own tax or legal counsel for advice. Any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax adviser.

The information, statistics, and opinions reported herein are from sources believed to be reliable. However, Simplicity Life and the author of this blog do not guarantee the truth, accuracy, and reliability of any source, fact and/or statistic cited and no do necessarily agree with any opinions expressed by such sources.

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