The primary purpose of life insurance is to provide a death benefit to help replace lost income and protect loved ones from the financial losses that could result from the insured's death. However, life insurance — and we are referring here primarily to cash value life insurance — also offers a number of tax advantages, many of which are unique to life insurance. The tax benefits of life insurance are:

1. You pay no current income tax on interest or other earnings credited to cash value. As the cash value accumulates, it is not subject to current taxation.
2. You pay no income tax if you borrow cash value from the policy through loans. As a rule, loans are treated as debts, not taxable distributions. This can give you virtually unlimited access to cash value on a tax-advantaged basis. Also, these loans need not be repaid. After a sizable amount of cash value has built up, it can be borrowed against systematically to help supplement retirement income and in many cases, never pay one cent of income tax on the gain. (Several cautions regarding policy loans: First, loans are charged interest and policy loans can reduce the overall value of the policy. Second, the cash value is potentially subject to income taxes when there is a withdrawal from or surrender of the policy, or if a certain ratio of death benefit to cash value is not maintained. Third, if the policy is a modified endowment contract, the loan may be taxable.)
3. Your heirs pay no income tax on proceeds. Your beneficiaries receive death benefits completely free of income taxation. Therefore, a $500,000 policy delivers $500,000 in benefits with no deductions and no withholding required.
4. You can avoid potential estate taxes and probate costs on policy proceeds. Placing ownership and naming beneficiaries outside your estate can avoid this situation, however. If you do this, the policy proceeds will not be included in your estate. However, to avoid estate inclusion, the policy must be transferred more than three years before your death. Consult your tax and legal advisors regarding your particular circumstances.

• Did You Know...?
  There are two general categories or types of life insurance: term and cash value (permanent) insurance.
  • Term insurance provides "pure" insurance protection. It pays a death benefit to beneficiaries if the insured dies during the term the policy is in force. If the insured lives, the policy expires without value at the end of the term. Or, in many cases, the policy can be renewed for an additional term, though generally for a higher premium.
  • A cash value policy is generally designed to provide long-term life insurance coverage, generally for the insured's entire life. (These policies include whole life and universal life, among others.) It also features a level premium and the opportunity to accumulate cash value. Permanent life insurance is designed to help pay for the death benefit protection in the insured's later years by keeping the premiums level for the life of the policy (unlike term insurance), and assuring that death benefit protection does not become prohibitively expensive in the insured's later years. The cash value is available to the policyowner through policy loans and other options, which reduce the death benefit.

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