Cash Value Life Insurance

• Cash value life insurance is the preferred type of policy to use when using life insurance for tax planning. The permanent nature of the contract combined with the inherent tax advantages of life insurance allow an individual to predictably and reliably reduce or eliminate the payment of taxes on certain income or estate taxes.
  
  

Tax Treatment oO Cash Values

• Cash values inside of a cash value life insurance policy are generally considered to be tax exempt. This means no income taz or other taxes are due during the accumulation period, where cash values are building up in the policy.
  
  

Taxation Of Withdrawals And Loans

• Withdrawals from the policy are not taxable up to the basis of the policy (the amount of premium you have paid). Every dollar withdrawn from a life insurance policy beyond the basis is taxable at ordinary income tax rates. Policy loans are considered loans and are not subject to tax. However, if the policy lapses, all loans will be "forgiven" and treated as income. Any income from the life insurance policy that is a gain above the basis in the policy will be considered taxable at ordinary income tax rates.
  
  

Estate Planning

• The life insurance death benefit is generally considered to be part of the insured's estate at death and is subject to estate taxes. Estate taxes can be paid out of the proceeds of the death benefit, however. Additionally, life insurance is sometimes used to create an estate simply because of the sheer size of the death benefit proceeds. Life insurance can be excluded from the insured's estate by setting up an irrevocable life insurance trust. These trusts remove the policy from the estate, but the policy owner and insured lose control over the policy and cannot use the policy for any personal gain.
  
  

Considerations

• Before using life insurance in your tax planning strategy, you should consult with a tax professional. Life insurance taxation is generally straightforward when the policy owner is an individual. However, advanced tax planning strategies involving irrevocable life insurance trusts will require the use of a lawyer.