Understanding the Tax Treatment of Life Insurance in Retirement

When people think about retirement planning, they often focus on IRAs, 401(k)s, and investment portfolios. But for many retirees, life insurance can play a strategic role, especially when it comes to navigating taxes. Whether you’re considering a new policy, already own one, or are weighing options for estate planning, it’s important to understand how life insurance is treated from a tax perspective.

Premiums Are Not Deductible

One of the most common questions we hear is whether life insurance premiums are tax-deductible. For individuals, the answer is no. Life insurance premiums are generally paid with after-tax dollars and cannot be deducted on your tax return. However, that doesn’t mean life insurance lacks tax advantages—it just means those advantages show up in different areas.

Tax-Deferred Growth Can Help Build Value

If you own a permanent life insurance policy—such as whole life or universal life—it includes a cash value component that can grow over time. One of the key benefits of this feature is tax-deferred growth. Just like with retirement accounts, you don’t pay taxes each year on any gains or interest that accumulates inside the policy. Over time, this tax-deferred compounding can add up and become a meaningful financial resource.

Accessing Cash Value in Retirement

For retirees who may be looking for flexible sources of income, life insurance can provide options. You can generally withdraw up to the amount you’ve paid in premiums (your cost basis) without triggering income taxes. Beyond that, policy loans can be taken out against the cash value of the policy, usually without tax consequences—as long as the policy remains in force and is not surrendered. It’s important to monitor these withdrawals and loans carefully, as excessive borrowing can reduce the death benefit or cause the policy to lapse, which may result in a taxable event.

Policy Surrenders May Trigger Taxes

If you decide to cancel (or “surrender”) a permanent life insurance policy, the IRS will compare the surrender value to your cost basis. Any amount above what you’ve paid in premiums is treated as ordinary income. For example, if you paid $70,000 into the policy and receive $90,000 upon surrender, the $20,000 gain may be taxable.

Death Benefits Are Generally Tax-Free

One of the most well-known advantages of life insurance is that death benefits are typically income tax-free to your beneficiaries. This makes it a powerful tool for legacy planning and family protection. However, if you retain ownership of the policy until your death, the proceeds may be included in your estate for estate tax purposes. To help mitigate this, some individuals use irrevocable life insurance trusts (ILITs) to keep the policy outside their taxable estate.

A Tool Worth Considering

When structured appropriately, life insurance can provide tax-efficient access to income, protection for loved ones, and help meet long-term financial goals. While it’s not a one-size-fits-all solution, for certain retirees, insurance may be a valuable part of a well-rounded strategy. If you’re looking for ways to build more flexibility and tax efficiency into your retirement plan, Click HERE to reach out to one of our professionals at Haven Financial Group today for a complimentary review of your finances.