If you own or are considering the purchase of a variable life insurance policy, you must become familiar with the features, benefits and financial aspects of this type of policy. Variable life insurance is a form of permanent coverage, and cash value is invested at the direction and discretion of the policy owner. While taxes are typically of minimal concern to the policy owner, variable policies present more potential for taxable events than other types.
Life Insurance Basics
Life insurance policies are contracts between an individual and an insurance carrier wherein the company agrees to pay the owner's beneficiary a predefined sum of money if the insured's death occurs while the policy is in force. At the same time, the owner agrees to pay the premium in the amount and at the intervals specified in the contract. Some policies have scheduled expiration dates, while others are designed to last for the remainder of the insured's life. Policy premiums differ based on a number of factors, including the insured's age, health status, the death benefit and the type of policy.
Variable life insurance policies, like all permanent insurance products, accumulate cash value. Small portions of each premium payment are set aside in a separate account connected to the policy. Eventually, the owner's premium payments actually become insufficient to cover the real cost of the insurance coverage, and that is when the cash value becomes relevant to the stability of the contract. The insurance policy is designed to reverse the flow of money from the cash-value account and use it to supplement the owner's premiums, thereby allowing premiums to remain fixed for the life of the policy.
Variable Life Insurance
Variable life insurance is a type of permanent coverage wherein the policy owner has complete and total discretion over the allocation of the invested cash value. Each insurance carrier maintains an array of sub-accounts into which the policy owner can divert accumulated cash value. If the sub-accounts perform well, the overall value of the cash account increases. However, if those accounts perform poorly, the cash value may decrease. Losing money in a variable policy's cash account may potentially threaten the future integrity of the coverage. Taxes are not due on the growth in a policy's cash value account regardless of the interest earned.
Sub-Account Transfers and Liquidation
Moving money between variable life insurance sub-accounts does not result in a taxable event. No fees or income tax liability is created by the transfer of money from one account to the other, regardless of how much money is moved, the timing of the transfer or the growth realized from the sale of funds. As long as the money remains within the variable policy, taxes will never be due. However, if the policy owner withdraws the money or borrows the money and fails to pay it back before termination of the policy, income taxes may be due on the aggregate amount above the sum total of his initial contributions.
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