No Income Tax for Beneficiaries
Upon death, a life insurance policyholder’s beneficiaries receive a death benefit, the amount of which is determined by the original policy agreement. Beneficiaries are not required to pay income tax on life insurance benefits—this is true for both term and whole life insurance policies. If a beneficiary receives a $250,000 cash benefit, no federal withholding or deductions are required on the benefit. Compared with a willed inheritance that is often subject to income tax and estate taxes, this is a major benefit of life insurance. However, if the deceased leaves his death benefit to his estate, the money may be taxed when willed to surviving family and friends.
No Income Tax on Earnings
During the lifetime of the policyholder, any interest or earnings accrued on a life insurance account is tax-free. The cash value of a whole life insurance policy steadily grows as a tax-free investment for the life of the policy. Neither policyholders nor beneficiaries are required to pay income taxes on the accumulated interest of a life insurance policy.
No Income Tax on Cash Loans
A whole life insurance policy is never canceled due to age, and it accumulates a cash value over time. This cash value is the amount the policy is worth if surrendered before death. Policy owners have the option to take out a low-interest loan from their own cash values tax-free and pay the money back to themselves over time. This benefit is only available to whole life insurance policyholders; term life insurance holds no cash value.