Cut Your Tax Bill With Permanent Life Insurance

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Cut Your Tax Bill With Permanent Life Insurance

Proper tax preparation should lower your taxes both while you are living and after you die. Permanent life insurance allows you to cover both bases at once, allowing you to pass your assets tax-free (income and estate) to beneficiaries while simultaneously building up tax-deferred cash growth within the policy.

Key Takeaways

  • Permanent life insurance may let you transfer assets to recipients tax-free, allowing you to avoid both income and estate taxes.
  • These measures will become increasingly crucial as people depend less on Medicare and Social Security.
  • If you believe that income and estate taxes may increase in the future, perpetual life insurance might assist you in transferring money into a refuge.
  • Other tax-saving strategies include establishing irrevocable life insurance trusts, maxing out retirement funds, and just giving money away immediately.

Your Beneficiaries

When most individuals consider life insurance, they anticipate how it would benefit those they leave behind. So, first and foremost, consider what life insurance can accomplish for your family. It may allow you to pay for your child’s future college tuition, create a retirement fund for your spouse, or just ensure that your survivors have enough money to live the lifestyle you choose for them.

Life insurance allows you to transfer a policy’s death benefit to recipients tax-free. Whether the death benefit is $50,000 or $50 million, your beneficiaries will not pay any income tax on the money they receive. What other financial instrument accomplishes that?

Beneficiaries, for example, may face IRS penalties if they inherit individual retirement accounts (IRAs), tax-deferred annuities, or qualified retirement plans. They may lose up to $0.35 for every dollar you leave them to federal income tax. This is not true of life insurance. Furthermore, life insurance ensures that your heirs get the funds (although the deceased may be responsible for estate taxes if the total amount of the estate including insurance death benefits exceeds the federal limits).

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The growing federal budget, the long-term healthcare issue, and the uncertain future of Social Security and Medicare have buried the government’s safety nets. And it is unlikely to improve over your lifetime.

However, you may be certain that the tax-deferred growth of cash within a life insurance policy is not subject to the vagaries of the persons in charge of Social Security and Medicare. Regardless of what the government does, you may use this money to augment your retirement income, pay for medical treatment, or do anything you choose with it.

That isn’t everything. If you receive Social Security payments, you may be unaware that you may be required to pay income tax on up to 85% of those benefits. Furthermore, most taxable income, including tax-free municipal bond interest, is included when calculating how much of your Social Security benefits you potentially lose to the IRS. This is not true of life insurance. Earnings from a life insurance policy are one of the few things that will not raise your Social Security tax liability.


Irrevocable Life Insurance Trusts

An irrevocable life insurance trust (ILIT) that acquires the insurance policy directly to exclude it from one’s personal estate is another alternative for high-net-worth people. You make a monetary contribution to the ILIT in order to obtain a permanent survivorship life insurance policy. The ILIT is the policy’s owner and beneficiary. Your heirs will not have to pay estate or income taxes on the death benefits if the survivor dies.

Give It Away Now

If you have limited resources and want your money to work for your heirs while you’re still living, as well as boost the amount they’ll get after you die, you might consider donating it to them now.

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For maximum advantage, your heirs may utilize a portion of the gift to purchase a life insurance policy on your life. Meanwhile, you may watch your loved ones enjoy the remaining funds right now.

Furthermore, the amount of the donation will be deducted from your taxable estate. Furthermore, since your loved ones are the policy’s owners and beneficiaries, they will not be subject to estate or income taxes on the death benefit when you die. They also won’t have to pay income taxes on the policy’s cash value rise while you’re alive.

Solving Other Tax Problems

Asset Allocation

Permanent life insurance comes in a variety of forms. Some policies, such as universal life (UL), pay a set interest rate on the policy’s cash value. Others, such as variable universal life (VUL), provide a plethora of investing alternatives. A large-cap stock fund, an international stock fund, a bond fund, or even a real estate fund are examples of these. The list goes on and on.

The performance of the underlying portfolio(s) you choose determines the rise of the cash value in VUL. This is added to your overall investment portfolio. Reallocations within the scope of the policy are not taxed. So, when it comes time to rebalance your assets, you won’t have to worry about paying income tax on earnings you take from the VUL as you make adjustments.

Maxed-out Retirement Plans

If you maxed out your 401(k) and IRA contributions this year, you should know that there are no limits on how much you may invest into permanent life insurance. Furthermore, you will benefit from tax-deferred growth and will be able to leverage the value of your estate.

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However, keep in mind that if you eventually cash out the insurance, you’ll have to pay taxes on it at your regular tax rate. So don’t think of this as a replacement for a cash emergency reserve. However, the insurance may have a borrowing clause that allows you to borrow from your cash value and therefore avoid the tax.

If you believe that income and estate taxes will increase, perpetual life insurance may help you shift capital into a tax-advantaged refuge.

Pennies on the Dollar

If income and estate taxes keep you up at night, life insurance might be the solution. Permanent life insurance is one of the most effective tax planning options available. It provides various novel approaches to addressing your estate and income tax responsibilities while resolving those difficulties for pennies on the dollar. If you use this method, next tax season may seem to be simply another beautiful spring day.

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