In the last post I spent
some time describing the benefits of supplementing your retirement income with cash value life insurance. My favorite is Equity Indexed Universal Life. I believe that, for a young person, these products deliver the most growth over time with the least risk. But there's another aspect of these solutions that I'd like to talk about- the tax benefits.
I heard a story about an insurance agent who was up against a stockbroker in trying to win the business of a client. This person had a certain amount of money to invest, and he had approached both of these fellows to prepare illustrations of future results. Of course, the stockbroker used an average rate of return north of 9% to calculate his, while the insurance agent was more conservative, using a 6% rate. As the two fellows presented their results to the client, the stockbroker was beaming. His future values were nearly 20% more over the time period. It was clearly, to the broker, no contest. Until the insurance agent interjected to the client, "Oh, I'm sorry. I didn't know that we were supposed to have to pay taxes on this money."
The agent got the account.
Life Insurance Policy Loans
If you want to understand why cash value life insurance can be such a powerful and tax favorable wealth building tool, you have to understand how poliicy loans work. As long as an insurance policy is not a Modified Endowment Contract (more on that later) you will pay no income tax if you borrow from the cash value. Loans are treated by the IRS as debts, not taxable distributions. Well, don't you have to repay a loan? No. In the case of life insurance, if the loan isn't repaid, the amount borrowed is simply deducted from the death benefit when you die. It's important that you don't borrow so much from the policy that you wipe out the cash value. If you do, and the policy lapses, you will create a taxable event and may have an ugly bill. Having said that, any good advisor can help you prevent that from happening.
- A tax-free loan on your policy can be utilized each year to supplement your other sources of retirement income. In those years when your stock portfolio is down, you may not want to take a withdrawal from that account. Cash value life insurance can take up the slack, thereby rescuing your portfolio.
- You are free to access this money any time. Or not. The Government has no say in how or when you spend this money. If you die your beneficiaries get the balance, also 100% tax-free. Your family wins, Uncle Sam loses.
- The main thing to guard against is taking too much money out, such that the policy lapses. Some of the newer policies now have the ability to add a rider that kicks in when you borrow money over the age of 65. This rider will guarantee that the policy will never lapse by paying the annual expenses of the insurance costs.
And What's Wrong With That?
These are great accumulation vehicles for growth and tax-free distributions, as well as creating an immediate estate. The younger you start them, the better. They make a great gift for grandchildren! Money can grow all during their childhood, then at college time be used for tuition, or for a down-payment on a home. If the child leaves it alone long enough it can generate an impressive retirement income. What a nice legacy to leave!
In the next post I'll spend a little time describing some of the loan provisions of these policies, and what you need to know when being shown illustrations, many of which are overblown and unrealistic.