Proper Tax Planning should do two things: reduce your taxes while you are alive, as well as after you die. Permanent Life Insurance gives you the potential to cover these two bases at once - you can transfer your assets income tax and estate tax free to beneficiaries and also build up tax-deferred growth of cash inside the policy.
Read on to discover how to make the most of this important tax planning tool.
When people think about life insurance, they generally envision how it will help those they leave behind. So, first let's talk about what life insurance does for your family. It can let you pay for a child's future college education, provide a retirement fund for your spouse, or simply make sure your survivors have the money to live the lifestyle you want for them.
Life insurance gives you the ability to transfer a policy's death benefit income-tax-free to beneficiaries. No matter how big the death benefit is - $50,000 or $50 million - your beneficiaries won't pay a single cent of income tax on the money they get. What other investment does that?
For instance, beneficiaries can get walloped by the IRS when they inherit IRAs, tax-deferred annuities and qualified retirement plans. They could end up losing up to 35 cents out of every dollar you leave them to federal income tax.
This is not the case with life insurance. Also, life insurance guarantees that your heirs will get that money. Term life policies offer death benefits only, so if you die, you win (so to speak). If you live past the length of the policy, you (or, more specifically, your family members) get no money back.
Permanent life policies offer death benefits and a "savings account" (also called "cash value") so that if you live, you get back at least some of, and often much more than, the amount you spent on your premium. You get this money back either by cashing in the policy or by borrowing against it.
Permanent life insurance is more expensive
As you might expect, permanent life insurance premiums are more expensive than term premiums because some of the money is put into a savings program. The longer the policy has been in force, the higher the cash value, because more money has been paid in and the cash value has earned interest, dividends or both.
The debate is all about that cash value. If you buy a policy today, your first annual premium is likely to be much higher for a permanent life policy than for term.
However, the premiums for permanent life stay the same over the years, while the premiums for term life increase. That extra premium paid in the early years of the permanent policy gets invested and grows, minus the amount your agent takes as a sales commission. The gain is tax-deferred if the policy is cashed in during your life. (If you die, the proceeds are usually tax-free to your beneficiary.)
The saying you always hear is, "Buy term and invest the difference." The fact is, it depends on how long you keep your policy. If you keep the permanent life policy long enough (and the market ever fully rebounds), that's the best deal. But "long enough" varies, depending on your age, health, insurance company, the types of policies chosen, interest and dividend rates, and more. The reality is that there is not a simple answer, because life insurance is not a simple product.
Guidelines to live by when buying
Even with all of these variables, there are some guidelines you can follow. The key is how long you plan to keep the policy. If the answer is less than 10 years, term is clearly the solution.
If it is more than 20 years, permanent life is probably the way to go.
What's in it for you?
The mounting federal deficit, the long-term healthcare crisis and the uncertain future of Social Security and Medicare have put the government safety nets deep in the hole. And it's probably not going to get better during your lifetime.
But you can take comfort in knowing that the tax-deferred growth of cash inside a life insurance policy is not vulnerable to the whims of the people who run Social Security and Medicare. This is money that you could use to supplement your retirement income, pay for medical care, or whatever you wish - regardless of what the government does.
That's not all. If you are collecting Social Security income, you might not know that could have to pay income tax on up to 85% of those benefits. Also, most taxable income, and even tax-free municipal bond interest, is counted when determining how much of your Social Security you can lose to the IRS. This is not the case with life insurance. Earnings that grow within a life insurance policy are one of the few items that will not increase the tax on your Social Security income.
Strategies To Use
Irrevocable Life Insurance Trusts
If you and your spouse have a net worth of more than $4 million, take a look at an irrevocable life insurance trust (ILIT).
You make a cash gift to the ILIT to purchase a permanent survivorship life insurance policy. The ILIT is the owner and beneficiary of the policy. When the survivor dies, your heirs will not have to pay estate and income taxes on the death benefits.
Give It Away Now
If you're of more modest means and would like to see your money working for your heirs while you're still alive, as well as increase the amount they'll receive when you die, then you might want to consider giving cash to them today.
For the greatest benefit, your heirs can use part of the gift to buy a life insurance policy on your life. Meanwhile, you'll be able to watch your loved ones enjoy the remainder of the money - right now.
Battistone Insurance Group