Life insurance and taxes Share Written By AAFMAA Team Tags Life Insurance Personal Finance 2016-03-16 The April 15 tax deadline is quickly approaching and, as Benjamin Franklin once wrote, “In this world, nothing can be said to be certain, except death and taxes.” Fortunately, life insurance can help you with both. It provides financial protection for your family when you die, and it can help you with taxes while you are alive. Although you should consult your tax advisor for specific advice in your particular situation, here are the most frequent questions that Members ask us about the tax implications of life insurance policies: 1. Do I pay taxes on the cash value growth in my whole life insurance policies? No. On your annual statement detailing your Value-Added Whole Life and ANNUITYLife policies, you earn interest based on AAFMAA’s crediting rate — currently 6.0% for 2016. The cash value growing on your policies pays for policy expenses and is not taxable. 2. When I die, will beneficiaries pay taxes on the death benefit? No. The IRS generally does not tax death benefit proceeds. 3. If my beneficiaries leave the death benefit on account with AAFMAA, will the interest that they earn be taxable? Yes. Although payment of the death benefit is not taxable (noted in question 2), the IRS considers interest paid on a death benefit as ordinary income and AAFMAA will report it on form 1099 if it is more than $600. If your beneficiaries chose a life annuity, they will get a stream of payments for life — part the original non-taxable death benefit and part taxable interest. 4. If I cash surrender my whole life policy, will I have to pay taxes? Yes, probably. When you surrender your policy, AAFMAA will pay you the cash value of the current policy. The government will tax the amount in that cash value that is greater than the premiums you paid. AAFMAA will report that amount, considered ordinary income, to you and to the IRS on form 1099. 5. If I borrow through a policy loan, is that loan taxable? No, for most “ordinary” whole life policies, the government does not tax the borrowed amount. For any policy that is a “Modified Endowment Contract” (MEC), including all ANNUITYLife policies and other policies for which you paid a single premium, the government would tax proceeds from the loan that are greater than the premiums you initially paid for it as ordinary income — similar to surrendering the policy. 6. If I exchange one life insurance policy for another, do I have to pay tax on the gain? No. In nearly all cases involving an exchange of one policy for another — known as a 1035 exchange — the government will not consider the gain as taxable income. The insurance company for the old policy will report the exchange to you on the form 1099-R, which you record as part of your taxes, but the proceeds are not taxable if they are entirely used to purchase another life insurance policy. 7. If I receive my life insurance proceeds as a Long-Term Care Settlement, do I pay taxes on those payments? No. Assuming that the settlement payments amount to less than the IRS maximum ($330 per day) and you use them for qualified long-term care expenses, the government will not consider them as taxable income. 8. Is interest that I pay on my Career Assistance Program (CAP) Loan deductible? No. The CAP loan is a consumer loan and, as a result, the interest paid is not deductible. If you have any specific questions, you should consult your tax advisor. If you need more information about your policy, please contact policy services at PolicyServices@aafmaa.com.