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Permanent Life Insurance Investment Advantages

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Permanent Life Insurance Investment Advantages

 

Life insurance premiums are generally a nondeductible personal expense. Policy dividends are treated as tax-free return of your capital, and death benefits are generally nontaxable. However, policies that include a cash value can offer several significant tax breaks for supplemental retirement savings. If you’ve maxed out available retirement plan contributions, you’d like to save more for retirement, and you need death benefit protection, life insurance may offer a solution:

  • Policy cash values grow tax-deferred. Gains aren’t taxed unless you let the policy lapse and cash out for more than you paid in. In that case, your taxable gain equals the cash value withdrawn minus premiums paid.
  • You can take cash from your policy, tax-free, by withdrawing your original premiums and borrowing against remaining cash values. You’ll pay (nondeductible) interest on the loan, but earn it back on the cash value. Many insurers offer “wash loan” provisions with little or no out-of-pocket costs. 
  • Some policies let terminally ill insureds take tax-free “accelerated benefits” to pay final expenses. 
  • Some states let terminally ill insureds sell their death benefits in tax-free “viatical settlements.” These sales, typically for less than the face amount of the policy but more than the surrender value, provide immediate cash to help pay their extremely high medical bills.

These advantages aren’t unlimited. If you stuff too much cash into the policy in the first seven years, it’s considered a “modified endowment contract” and all withdrawals are taxed as ordinary income until you exhaust your inside buildup.

Insurers offer three main types of cash-value policies for different investors. The key is finding a policy that matches your investment temperament:

  • “Whole life” resembles a bank CD in a tax-advantaged wrapper, with required annual premiums and strong guarantees.
  • “Universal life” resembles a bond fund in a tax-advantaged wrapper, with flexible premiums but less strong guarantees.
  • “Variable life” lets you invest cash values in a series of “subaccounts” resembling mutual funds in a tax-deferred wrapper. You can choose “variable whole life” with required premiums and stronger guarantees, or “variable universal life” contracts with flexible premiums and less strong guarantees. “Private placement” contracts for cash values of $1 million or more may even let you choose your own hedge funds or separate account managers.

 

 

 

 

 

 

 

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