Life Insurance: It's More than a Death BenefitSubmitted by Stone House Investment Management, LLC on October 26th, 2017
Life insurance is universally recognized as an essential pillar of a financial plan for providing much needed capital in the event of a breadwinner becoming deceased. It is also fundamental to other planning needs, such as estate planning to pay for settlement costs and taxes, and business planning for business continuation or key person protection. However, considering the remarkable tax properties of permanent life insurance, it can also be considered as an essential component of a long-term financial plan. Why is life insurance more than just a death benefit? Here are three reasons why:
Increased After-Tax Income in Retirement
While IRAs and 401(k) plans are considered essential retirement planning tools, they have several disadvantages. The first is that they are merely tax-deferred vehicles. Although this is an advantage while accumulating capital, it can be a big disadvantage during the distribution phase. Taxes are due on distributions when the money is needed most and at an uncertain tax rate. That makes these traditional retirement vehicles uncertain at best and a diminishing asset at worst.
By converting these accounts over time into a permanent life insurance plan, tax-deferred becomes tax-free when the income is needed. Also, income taken from cash value life insurance is not included in the Social Security tax calculation as is the income from IRAs and 401(k) plans.
This can be especially advantageous when having to deal with required minimum distributions at age 70 ½, which can force you into a higher tax bracket. By taking distributions from an IRA or 401(k) plan and funding a life insurance policy, you can reduce your retirement plan balances to avoid a possible RMD problem while creating a reservoir of tax-free income.
Improved Investment Performance
There is an ongoing debate in financial planning circles over whether life insurance should ever be used as an investment. Some planners view life insurance as an expense. While there are additional costs associated with life insurance, there is no other asset that can perform the way a permanent life insurance plan can, especially for long-term objectives such as retirement.
As an investment, life insurance not only removes the tax risk associated with most other vehicles, it provides a valuable hedge against stock market volatility and interest rate risk associated with bonds. Depending on the type of permanent life insurance, it also provides guaranteed returns. Investment models have shown that when cash value life insurance is included as an asset in an investment portfolio, it can increase long-term investment performance while reducing portfolio volatility. By any measure, that is not an expense.
More Control Over Income and Taxes
Most people don’t think of life insurance in terms of what it can do for them while they are living. However, considering that cash value life insurance is the only type of asset that can allow you to accumulate capital tax-free and take tax-free withdrawals (up to the cost basis and thereafter as tax-free loans) anytime without penalty, it is unparalleled in its planning opportunities.
Most investment income can potentially trigger stealth taxes, such as alternative minimum tax, Social Security tax on income, or the 3.8% additional tax on net investment income. It can also increase taxes by pushing your income up through qualification thresholds for phased-out deductions, tax credits and exemptions. Income taken from life insurance is not considered investment income; therefore it can actually lower your taxes.
By the way, all the while you have been enjoying the tax benefits of life insurance, you have substantially expanded your legacy estate with a tax-free death benefit.
While life insurance should be viewed by most people as an essential protection vehicle, when used in the right situations, the remarkable properties of life insurance should be viewed as a gift for people who have portfolios to protect and taxes to save.
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*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2014-2017 Advisor Websites.