Tax Advantages of Life Insurance
Permanent life insurance can be a key asset for many individuals due to its tax-advantaged treatment. No other financial tool becomes an instant asset upon the death of the insured. There are three key aspects of life insurance you should understand:
- Premium payments
- Death benefit
- Cash value
1. Premium Payments
A life insurance policy is purchased with premium payments you makes to a life insurance company. The following are several key questions and answers related to premium payment.
Are there contribution limits for life insurance policies?
Unlike other tax-advantaged assets like Roth IRAs, there are no contribution limits based on your income. However, there is a limit set by the IRS determined in large part by the amount of death benefit being purchased.
What are the benefits of a well-funded policy?
A well-funded policy is funded close to the legal limits in order to achieve the most amount of premium growing tax-deferred. This reduces the risk the policy will lapse or will require additional premium payments, and potentially produces higher cash values.
How do charges and fees impact accumulation value?
While permanent life insurance does offer growth potential, you should understand several charges are assessed to your premiums before contributions reach the cash value portion of their policy:
- In many cases, charges and fees associated with premium payments may be higher than the purchase payments for a capital asset or a 401(k)
- There are charges associated with maintaining the death benefit that do not exist in capital assets or many retirement income assets
- Life insurance is priced around a mortality charge determined by age, gender and general health of the insured
2. Death Benefit
Your’ premiums pay for a life insurance policy’s income tax-free death benefit – the primary purpose of this tool. If the insured dies, the death benefit can provide:
- Money for beneficiaries at a time when they need it the most — for income replacement and debt reduction or estate planning
- Replacement value for assets going to a charity
- Estate equalization for a family business
- A strategy to transition a business to someone else
3. Cash Value
While you see the value in a life insurance policy’s death benefit, you might not fully understand the cash value component of permanent policies. Understanding cash value accumulation is key to realizing the full value of life insurance as a financial tool. A well-funded policy that has good performance throughout the life of the contract can potentially:
- Act as an “opportunity reserve” when you need additional funds
- Provide supplemental retirement income
- Potentially lower your average tax rates in retirement
In our next blogpost, we will discuss the distributions from permanent life insurance policies.