Creating a financial plan without including life insurance is a risky business. Life insurance can protect your family in the event of your untimely death, and some types of life insurance build cash value and can be used as part of your retirement plan. Life insurance has some nifty tax benefits, like tax-free proceeds to your beneficiaries. One tax benefit you don't get, however, is a tax deduction for your life insurance premiums.
Premiums You Can Deduct
The Internal Revenue Service allows you to deduct certain types of insurance premiums, provided you itemize your deductions and meet certain specific requirements. For example, you can include health insurance and long-term care insurance premiums that you paid yourself with your other qualifying medical and dental expenses. For the 2012 tax year, you can only deduct the amount of your medical and dental expenses that exceed 7.5 percent of your adjusted gross income. The IRS does not consider life insurance as a type of policy that covers medical care or qualified long-term care services, so you cannot include your life insurance premiums along with your medical and dental expenses deduction.
Certain types of life insurance, such as whole life insurance, include a savings component in addition to an insurance component. The savings component may have either a guaranteed fixed growth rate or a variable growth rate, but all growth in your whole life insurance policy occurs on a tax-deferred basis. You can borrow against your policy's cash value without incurring a tax liability, and if you hold the policy long enough, the dividends produced by the policy might even be large enough to pay your premiums. The IRS typically considers your life insurance dividends to be a tax-free return of premiums until the amount of the dividends exceeds the total amount you paid toward your policy. While you can enjoy tax-free income from your life insurance policy, you can't deduct the cost of your premiums.
You can make contributions to your traditional individual retirement account using pre-tax dollars, and you can use the funds in your IRA to purchase almost any kind of investment you like. There are a few investments that the IRS prohibits from being held in an IRA, including collectibles and life insurance. While you can deduct your traditional IRA contribution when you file your federal income tax return, you can't use your IRA dollars to buy life insurance.
There is one exception to the no-life-insurance deduction rule, and that applies only if you own your own business. You can deduct premiums for life insurance policies that cover your company's officers and employees, provided you are not a beneficiary under the contract, either directly or indirectly.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.