Whole life, universal life, and single-premium life plans, which mix investments and insurance, are tax-favored.
Your premium is invested in part. Earnings on the cash value are not taxed until the insurance is cashed in. If the insurance is still in existence when you die, the profits are sent to your recipient tax-free.
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Withdrawals and Loans
The premium for single-premium insurance is paid just once. The death benefit is modest, but the full premium is promptly invested in your choice of several stock and bond funds. The cost of insurance is deducted from your salary.
Earnings grow tax-free, much like money in an individual retirement account.
You may borrow against the single-premium insurance until recently. The loan’s interest was offset by profits, which were credited to your cash worth. While Congress no longer permits tax-free loans on single-premium policies, a policy loan is not deemed a taxable withdrawal provided you pay premiums for at least 7 years.
Some plans provide tax-free partial withdrawals of cash value. The IRS presumes that the initial money withdrawn is a refund of your premiums rather than profits. Additional withdrawals are deemed taxable income if they exceed your entire investment in the insurance.
Annuities
An annuity is a contract between you and a life insurance company in which you make a single or series of payments. In exchange, the insurance sends monthly payments to you, either immediately or at a later date.
Annuities normally provide tax-deferred profits growth and may contain a death benefit that pays a specified minimum amount to your beneficiary, such as your entire purchase payments. Annuities are classified into two types:
Fixed annuity: You get a certain amount of money for a set length of time, such as $400 each month for life. Your investment in a fixed annuity receives interest at a rate determined by the insurance company, which might fluctuate in accordance with market interest rates.
Variable annuity: The amount of income you get may change based on the performance of your assets. You may pick from a variety of funds — stock, bond, money market, and so on — and your return is determined by the performance of the assets you choose.
There is no tax owed until you withdraw cash from the contract, presumably in retirement, either as a lump sum or by annuitizing the contract and having the corporation make payments to you for the rest of your life.
Most contracts impose surrender penalties over the first three years if you wish to withdraw money early. Any annuity profits are taxable, and if you are under the age of 5912, you must pay a 10% penalty tax.
