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Minimize Administrative Costs and Burdens to Achieve Tax Deferral with Permanent Life Insurance

Updated: Apr 12, 2021

Historically, life insurance has been purchased as a means to create immediate liquidity upon death. This concept is still a guiding principle behind most life insurance. In addition to liquidity needs at death, life insurance has become an extremely viable investment vehicle. Many of today's life insurance products offer an individual a tax advantaged way to save after-tax income. Investment oriented permanent life insurance utilizes cash value to provide several benefits during your lifetime in addition to benefits upon your death.

Life insurance, if structured properly, can be a dynamic investment vehicle because of its income tax attributes. These attributes are (i) cash value build up is income tax-free if a policy is held until death and income tax-deferred if the policy is surrendered before death, (ii) death benefits are income tax-free, (iii) cash may be withdrawn up to an amount equal to cumulative basis on an income tax-fee basis, and (iv) gains within the policy can be borrowed income tax-free. In addition to the last two attributes, policy owners can now also structure life insurance policies to fund long-term care liabilities as well as give older insureds (or insureds with impaired health) the option to sell their policy for cash in a life settlement.

At first glance, investment oriented permanent life insurance is counter-intuitive. Generally, an individual desires the maximum death benefit for the lowest premium. Investment oriented permanent life insurance turns this logic on its head. It calls for the maximum cash to be deposited into the policy via premium payments for the lowest possible death benefit. The lowest death benefit utilizes the true value of a life insurance policy's tax-free build up of cash value by reducing annual policy mortality charges. In general, the life insurance carrier's mortality or cost of insurance is based upon the death benefit less the cash value. This difference is referred to as the net amount at risk. Thus, a lower net amount at risk decreases the cost of insurance while maximizing tax-free build up. With this understanding, the investment oriented funding approach makes sense.

Overview Video (2:36): Understanding Term and Permanent Life Insurance

When to Use Permanent Life Insurance for Living Benefits?

Historically, the government has allowed several retirement vehicles by which to supplement retirement income. However, what the government has given, it has also been slowly taking away. Today, very few employers offer a traditional pension plan. This leaves more individuals responsible for their retirement savings. Individuals are responding by contributing their own income into various retirement vehicles. Many employers offer contributory plans; however, these plans are limited by how much an individual can contribute on a pre-tax basis each year. Also, cash is not liquid in these plans until after age 59 1/2. For individuals maximizing all pre-tax retirement savings options, a properly structured investment oriented permanent life insurance policy is an excellent product to evaluate for saving additional after-tax dollars.

With a permanent life insurance policy, a policy owner can exercise several options:

  1. Transfer, income tax-free, cash value to a new life insurance policy;

  2. Surrender the policy, claim its surrender value at the time of surrender and pay taxes on the gains;

  3. Make a tax-free exchange with the cash value for a tax-deferred annuity;

  4. Withdraw and borrow on a tax-free basis from the policy for cash needed and ultimately cause beneficiaries to receive a death benefit net of any outstanding loan;

  5. Fund long-term care liabilities in retirement;

  6. Sell the policy for cash in a life settlement; and/or

  7. Hold the policy until death.

We are here to help you evaluate how to use a permanent life insurance policy for additional tax-efficient benefits in retirement. Schedule a call with our team - we look forward to having the opportunity to speak with you.

This is not an offer to sell a security or insurance product. This information is provided for informational purposes only and should not be construed as legal or tax advice. You should discuss your circumstances with a financial professional before making any decisions. This material and the opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.


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