By Joel Ray
Retirement and tax planning at any stage in life entails a very detailed set of monetary strategies, accounting for various factors such as regular day-to-day expenses, accessible funds for emergencies, future goals, rising costs of inflation, and more. A tax saving insurance plan is an essential part of financial planning, both during your lifetime and after.
Permanent Life Insurance Benefits
A permanent life insurance plan offers better tax savings than, say a term insurance tax benefit, and these are twofold:
Benefits for Your Beneficiaries
The future is unpredictable, but even with the uncertainty of life, investing in permanent life insurance offers financial stability for you and your family. This goes beyond death benefits, since the cash value can be used to pay for education, retirement and other expenses during your lifetime too.
When you buy insurance as a replacement for the financial security you provide your loved ones, the last thing you want is for them to be paying heavy taxes on it. Proceeds from most retirement plans (like IRAs) and even tax-deferred annuities incur up to 35% in federal income tax when someone inherits them!
With the life insurance income tax exemption, however, your beneficiaries are not liable to pay income tax on policy benefits, which helps with your estate planning and distribution. Regardless of how large or small the payout from the policy, your beneficiaries will pay zero tax on it.
Benefits for You
The cost of healthcare and assisted living services is growing every day, as is life expectancy, which increases the possibility that you might need long-term care at some point. Coupled with growing concerns over the current federal deficit and the potential instability of government-sponsored plans, you need a financial backup in place.
With a tax saving insurance plan, you can sleep better at night knowing that if you ever need long-term care, the tax-deferred cash value growth offers you a ready source of funds. The accumulated cash value also remains untouched by the ups-and-downs of Social Security and Medicaid.
When you withdraw or borrow against your policy, an additional benefit is the fact that your Social Security will not be taxed as a result of this influx of funds. Income from most investments counts as taxable money, which is taken into account when your Social Security payout is determined, but not your life insurance proceeds.
Other Tax Benefits of Life Insurance
In addition to the impact on taxable death benefits and your financial legacy, here are a few other ways that life insurance tax saving plans can help you:
Setting up a Tax Shelter
Any smart investor knows that the moment your money starts growing, your tax burden does too, and it’s essential to pre-plan if you’re expecting your gains to be substantial.
With a permanent life insurance plan, you can transfer part of your accumulated wealth into a shelter where it’s protected from higher income and estate taxes. This helps you minimize taxes during your lifetime and reduces the tax impact on your heirs too.
Allocating or Rebalancing Assets
Some types of permanent life insurance give you more choices when it comes to how your money will be invested. For instance, you receive a fixed rate of interest on your funds with a UL (Universal Life) policy, but are offered a wide range of investment options with a VUL (Variable Universal Life) plan.
With the latter, your policy’s growth depends on the performance of the investment portfolio you choose, which could include international stock funds, bond funds, large-cap stock funds or even real estate funds. When you reallocate these within the VUL policy, you don’t have to pay income tax on the gains you’ve made.
Additional Retirement Savings
While there are restrictions on the maximum contribution you can make to your IRA and 401(k) retirement funds, there are no such limits with life insurance.
If you’ve maxed out your other savings vehicles, use a permanent life insurance plan as a form of tax-deferred investment in addition to the financial security it provides. Keep in mind that when you do make withdrawals from the plan, you will pay taxes on the funds withdrawn (which you can avoid by taking a loan against it instead).
Get Maximum Benefits from Life Insurance Income Tax Section
When it comes to life insurance and tax exemptions, there is a fruitful relationship between the two and it’s advisable to make them work for you. Here are a couple of basic strategies that you can use to reduce your tax burden with life insurance, depending on your current financial situation:
Set Up an ILIT (Irrevocable Life Insurance Trust)
You can set up an ILIT with your spouse, if your total net worth as a couple is over $4 million, and buy a permanent survivorship life insurance policy by making a cash gift to the trust, which acts as the policy’s owner and beneficiary.
This is a very smart strategy for passing on tax-free funds to your heirs, since they will not be liable for estate tax or income tax on the death benefits (after the death of the surviving spouse).
Give Your Heirs a Cash Gift
If your net worth does not allow for an ILIT, you can still pass tax-free funds to your heirs by making them a cash gift. If the recipients use part of this money to invest in life insurance for you, the benefits will be even more extensive.
You can rest easy knowing that your beneficiaries will receive tax-free payouts in case of your death, but can use the funds you’ve given them while you’re still alive. As a bonus, the taxable part of your estate reduces, and your heirs won’t have to pay income tax on the cash value growth of the policy during your lifetime either.