Many people see their life insurance policies as financial safety nets and wealth transference vehicles for their loved ones. However, beyond the primary benefit of providing financial security to your family, your life insurance, especially whole life or indexed universal life, also offers powerful tax advantages that will help you achieve more efficient wealth accumulation.
The most well-known tax advantage of life insurance is, of course, the tax-free death benefit. When the insured dies, the designated beneficiaries receive a lump sum payment known as the death benefit. In most cases, this death benefit is free from federal income taxes. When people consider adding life insurance, they typically envision how their policy will help the people they will leave behind when they pass away.
A life insurance policy can help pay for a child or grandchild’s college education, pay off any outstanding debts, such as a car loan or mortgage, or give your loved ones enough cash to maintain their lifestyles after you pass. No matter how significant a death benefit may be, whether it is $250,000 or $20 million, your beneficiaries (in most instances) won’t pay a penny in income tax. Very few other financial vehicles can claim this tax advantage. For example, your beneficiaries will probably get blindsided by the tax bills they’ll get from their inherited qualified plans such as IRAs and 401ks. In some instances, beneficiaries could lose as much as 35 cents of every dollar you leave them!
With the nation’s debt rising by the second, the iffy future of social programs such as Medicare and Social Security, and unrestrained inflation, the tax-deferred growth of permanent insurance such as whole and universal life has become even more desirable.
For now, at least, the cash value in a permanent life insurance policy is off limits to the meddling of politicians and bureaucrats. This aspect of permanent life insurance will give you greater peace of mind, knowing that you can use the money in your policy to supplement your pension, Social Security, or other retirement accounts. Also, many people don’t realize that when the time comes for you to collect Social Security, you may end up paying tax on as much as 85% of your benefits, depending on your total income.
And most taxable income, even income from tax-free municipal bond interest, gets counted when the IRS decides how much to tax your Social Security. However, this is not true for money earned from a permanent life insurance policy. Your policy’s growth is one of the few assets that won’t increase your tax liability for Social Security.
If you’re like me, you don’t think taxes are going down in the future. Permanent life insurance can help you put more money into your tax-deferred plans or transfer your money into another tax-sheltered asset, such as an irrevocable life insurance trust. Many creative yet legal ways exist to reduce your and your heirs’ tax bills using life insurance. Talk to your tax expert or financial advisor about these and other proven tax mitigation methods.
There are multiple kinds of permanent life to meet your needs.
As I mentioned, permanent life insurance comes in several “flavors.”
Some, for instance, universal life (UL), pay fixed rates on cash within the policy. Variable universal life (VUL), on the other hand, offers nearly endless investment options. These could include large-cap stock funds, international funds, or real estate funds.
The cash value growth in a variable universal life policy depends on the performance of the underlying portfolios chosen. These gains become part of the total investment portfolio. When you reallocate cash within your policy, the reallocation is not a taxable event. This means that when it is time to rebalance your policy investments, you won’t have to worry about paying income tax on profits if you make changes inside the VUL.
Have you made the maximum contributions to your qualified plans?
If you have contributed the maximum amount to your 401k or IRA, a permanent life insurance policy can help. There are no caps on how much money you can put into one of these policies. An added advantage is that by using permanent life insurance to save for retirement, you benefit from tax-deferred growth and may leverage your estate’s value.
However, if you take cash out of the policy, you’ll pay taxes on it at your ordinary tax rate unless you have a specially-designed policy with a loan provision built in. Policies with loan provisions allow you to borrow from their cash value without paying taxes. Policy loans are not considered taxable income. And, if the policy remains in force until the insured dies, any outstanding loan balance gets deducted from the death benefit. Ask your permanent life insurance specialist to explain precisely how these policies work.
Summing it up:
Insurance can be a viable solution if you worry about estate or other taxes. Permanent life insurance, such as IUL, VUL, and whole life, is among the most potent tax planning tools. Permanent life insurance gives you several unique ways to reduce your estate tax and income tax liabilities, create a tax-advantaged legacy for loved ones, provide the groundwork for business succession planning, and increase charitable giving. Consulting with a qualified tax professional or wealth advisor can help you leverage the tax advantages and safeguard your wealth while securing the financial futures of the ones you leave behind.
