Life insurance is an attractive tool for estate planning because the proceeds received at death are generally not taxable. If you have, or are planning to purchase life insurance, you should be aware that the tax implications will depend on whether or not it is exempt from taxation of the accumulated income.
Policies issued before December 2, 1982 fall under the “old rule” status. These policies are exempt from accrual taxation. Policies issued after December 1, 1982, fall under the “new rules” and may or may not be exempt.
To distinguish the exempt or non-exempt status of a policy, an exemption test must be administered by the insurance company on each anniversary date of the policy. A policy is considered exempt if its emphasis is “benefits on death.” Non-exempt policies are those policies that offer a substantial lifetime investment including annuity contracts. Exempt policies must meet current test requirements and must also meet prospective future test requirements on every anniversary. You can obtain information about the tax status of your policy from your insurance company.
The exempt status of a policy can change for a variety of reasons and each has different consequences. Exempt policies that don’t meet this exemption test are then granted a 60-day grace period to return the policy to its exempt policy status. In most cases, this requires withdrawing money from the policy.
The tax on non-exempt policies must be paid at least every three years. Holders of policies acquired after 1989 must pay tax annually. If you’re insured under a non-exempt policy, then upon your death any investment income generated within the policy that has not yet been taxed will be considered taxable income. The proceeds received on death from an exempt policy, including the income earned under this policy, are not taxable.
Tax may also be payable if you transfer ownership, relinquish or convert your policy. Dividends and policy loans may also have tax consequences that should be looked at carefully.
Exercise extreme care when replacing any policy, particularly an “old-rule” policy, because the tax outcome may be expensive.
The rules and regulations surrounding life insurance policies and taxation change over time. You should talk to your insurance or financial advisor before making any decisions regarding your policy. Members of Advocis have the specialized training essential to help you make the right decisions.
There are a host of strategies using life insurance policies that can help defer tax by way of tax sheltering, provide tax-free cash on death to conserve an estate or help equalize an estate. When structured properly, an insurance policy can enhance the amount that can be flowed out to beneficiaries by way of a corporation’s capital dividend account.
Take the time to sit down with a trusted life insurance advisor and explore the many benefits that life insurance and related products bring to the table.
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