Seven Life Insurance Tax Benefits Many People Are Unaware Of

Transcript of Podcast Episode 398

Hello, this is Bill Rainaldi, with another edition of Security Mutual’s SML Planning Minute. In today’s episode: seven life insurance tax benefits many people are unaware of.

Is there really such a thing as a simple financial product? Maybe. But in many—if not most— cases, tax law introduces complications that can make some products difficult for the typical consumer to understand. But with that comes opportunity. You’re going to pay taxes anyway, but along the way, you might as well make an effort to minimize them.

Life insurance, particularly permanent life insurance, offers its share of tax complexities. But many of these, if you truly understand them, can help produce advantageous after-tax results. Here are seven tax benefits you might not be aware of:

1) In most cases, the life insurance death benefit is income tax-free. This is probably the biggest, and most well-known, tax advantage of life insurance. When you receive a large sum of cash after someone dies, the taxation depends on where the money comes from. For example, if you inherit an individual retirement account or IRA, you are likely to be facing a significant income tax bill. Not so with a life insurance death benefit. We must caveat, that we are referring to typical lump-sum payouts directly to a named person that are generally income tax-free. Exceptions can occur due to interest earnings, estate size, policy transfers, or complex ownership structures. These are not typical scenarios, however.

Using the typical scenario, the difference is potentially huge. If you’re in a 32 percent tax bracket for example, your $1,000,000 of pre-tax cash will only be worth $680,000 after tax. But with the few exceptions already referenced, a $1,000,000 of life insurance death benefit is worth the full $1,000,000 after tax.

2) Tax-deferred growth of cash value. In most circumstances, a permanent life insurance policy will generate a cash value, which is also the amount you would receive if you surrendered the policy. Note that a term life insurance policy generally does not have any cash value.
The cash value within a permanent policy—in most but not all cases—grows on a tax-deferred basis, unlike, say, a mutual fund or a stock that pays a dividend. The gains within the policy are not taxed from year to year. Gains only become taxable in certain circumstances, such as a cash surrender of the policy, certain withdrawals above your taxable basis, or if the policy lapses.

3) Tax-free borrowing via policy loans. You have the ability to borrow against your policy’s cash value on a tax-free basis, within limits, as long as the policy stays in force. Tax-wise, loans are treated as debt, not income. As with most types of loans other than home mortgages, interest payments are not deductible. But unlike a bank loan, the loan decision is entirely yours. You don’t have to ask anyone else to approve your application, and while you will continue to accrue interest, you are not required to pay the loan back at any particular time.

4) Receiving an “accelerated death benefit” that is generally tax-free. If you are chronically or terminally ill, you may be able to access a portion of the policy’s death benefit while you are still living if the policy includes a chronic or terminal illness accelerated death benefit provision. From a tax perspective, assuming certain conditions are met, the distribution would be treated as an income tax-free acceleration of the eventual death benefit payment.

5) Tax-free exchanges via IRC Section 1035. You can also exchange one life insurance policy for another without being immediately taxed on any gains.

There are, of course, some rules you’ll need to follow. When the first policy is transferred, the money needs to go directly from the original transferring insurance company to the new insurance company. Of course, if the original company is also issuing the new policy then there is no physical transfer. The main thing is that you can’t take receipt of the policy proceeds yourself during the exchange. Also, the new policy must have the same owner and insured as the old one. No material changes may occur but if you follow the rules, a Section 1035 exchange can be an opportunity to improve the life insurance benefits over the ones in your original transferred policy. The new policy may have a higher or less expensive death benefit, performance implications, or riders that may not have existed before or are better, all without any current tax implications.

6) A life insurance policy can help with estate taxes. Not many people think about this one. After all, federal estate tax law, as of 2026, allows you to leave up to $15 million to your heirs ($30 million for a married couple) before any federal estate tax is assessed.[1] But state estate tax laws are different. If you live in certain states, such as New York, Maryland or Massachusetts, the threshold is much lower.[2]

Estate tax rates can be high, and an Irrevocable Life Insurance Trust (ILIT) can help ensure the associated life insurance proceeds are not included in your taxable estate, thus minimizing or helping to avoid a potentially significant estate tax. If this sounds like something you’d be interested in, it is recommended to consult with a qualified life insurance professional.

7) In a business situation, life insurance can potentially have tax advantages. Businesses can find ways to use life insurance in a tax-efficient manner. This might include buy-sell agreements, key-person insurance, split-dollar arrangements, or executive benefit plans.

Premiums paid are generally not deductible for the business, but these strategies can still provide significant tax advantages to both the business and the insured individual(s).

And here’s a bonus tax-advantaged use of life insurance:

8) Potential retirement income. If the circumstances are right, a cash value life insurance policy can be used to supplement retirement income. This doesn’t happen overnight; it’s a strategy that generally needs to be planned out well in advance.

Once a life insurance policy has been well-capitalized (and this usually takes someone many years) it is possible to access cash value through periodic tax-free loans and withdrawals to the policy’s tax basis. This strategy can provide retirement income that is both tax-free and not subject to Required Minimum Distributions or RMDs. Such loans and withdrawals are generally not guaranteed.

As is always the case with taxation, things can become very complicated, and there are some pitfalls to watch out for. One of the most notable is something called a “modified endowment contract.” The IRS specifies how much money can be paid into a life insurance contract, and if you exceed those limits, many of the tax advantages could be lost. It’s too complicated to discuss in detail here, but it’s a good illustration of why you need the help of a qualified life insurance professional.

Interested in pursuing some of the special tax advantages discussed here? Your Security Mutual Life insurance agent can help. Your Security Mutual Life insurance agent can augment or help assemble your financial team and coordinate with your attorneys and tax professionals to review your situation, and to determine the insurance plan that will best suit your needs and objectives.

[1] Internal Revenue Service. “Estate Tax.” IRS.gov. https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax (accessed August 6, 2026).

[2] Loughead, Katherine. “Estate and Inheritance Taxes by State, 2025.” Taxfoundation.org. https://taxfoundation.org/data/all/state/estate-inheritance-taxes/ (accessed August 6, 2026).

This podcast is brought to you by Security Mutual Life Insurance Company of New York, The Company That Cares^®. The content provided is intended for educational and informational purposes only. Information is provided in good faith. However, the Company makes no representation or warranty of any kind regarding the accuracy, reliability, or completeness of the information.

The information presented is designed to provide general information regarding the subject matter covered. It is not to serve as legal, tax or other financial advice related to individual situations, because each individual’s legal, tax and financial situation is different. Specific advice needs to be tailored to your situation. Therefore, please consult with your own attorney, tax professional and/or other advisors regarding your specific situation.

To help reach your goals, you need a skilled professional by your side. Contact your local Security Mutual life insurance advisor today. As part of the planning process, he or she will coordinate with your other advisors as needed to help you achieve your financial goals and objectives. For more information, visit us at SMLNY.com/SMLPodcast. If you’ve enjoyed this podcast, tell your friends about it. And be sure to give us a five-star review. And check us out on LinkedIn, YouTube and Twitter. Thanks for listening, and we’ll talk to you next time.

Tax laws are complex and subject to change. The information presented is based on current interpretation of the laws. Neither Security Mutual nor its agents are permitted to provide tax or legal advice.

The applicability of any strategy discussed is dependent upon the particular facts and circumstances. Results may vary, and products and services discussed may not be appropriate for all situations. Each person’s needs, objectives and financial circumstances are different, and must be reviewed and analyzed independently. We encourage individuals to seek personalized advice from a qualified Security Mutual life insurance advisor regarding their personal needs, objectives, and financial circumstances. Insurance products are issued by Security Mutual Life Insurance Company of New York, Binghamton, New York. Product availability and features may vary by state.​