Is it true that after 10 years the proceeds of a variable life policy and the cash value are tax-free if you want to withdraw the money?
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Asked October 25, 2011
Life insurance policies are not tax-free, they are tax-deferred. What this means is that eventually the money accrued in the account will become taxable unless you take specific steps to prevent that from happening. The easiest and most common way to keep the money in a life insurance policy from being taxed is to assign ownership to someone other than yourself, such as the primary beneficiary or the executor of your estate. However, if you assign someone else as the owner of the policy, you are no longer able to enjoy the benefits of the policy, the new owner is.
As you pay premiums into a variable life insurance account, it accrues cash value. After 10 years of paying into the policy, you should have a sizable accrual value, not only because of what you have paid in, but because that money continues to earn interest as well. This cash value can be borrowed against without any taxation, because it is money which technically already belongs to you. Since you had to pay taxes on the money when it was originally earned, you cannot be taxed for the same money again. It is not income, it is your previously earned money which has been in a special type of savings account.
If you close out the policy, you will receive the accrued amount, plus interest. However, closing out the policy means that the entire cash value is immediately taxable. In general, after you have paid into a life insurance policy for 10 years, it makes very little sense to close the policy out when you can borrow against it and still retain the coverage.
Variable life insurance policies are intended to perform as financial tools throughout the life of the policy owner. You can borrow from the cash value, influence how the accrued value is invested, or close out the policy to get the accrued cash value. Whether the money in the policy is taxable will depend on how you use it, who is the assigned owner and how the money from the policy is accessed.
Answered October 25, 2011 by Anonymous