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Tags: Health Topics | Money | life insurance | college savings | home repair | auto repair | wealth preservation and estate planning

Bezozi: Six Reasons Why Life Insurance Makes Sense

life insurance
(AP)

Harvey Bezozi By Wednesday, 27 October 2021 04:57 PM Current | Bio | Archive

While most people recognize that life insurance provides general peace of mind, they often underestimate the tax and financial advantages the right policy has to offer. Among many other benefits, a thoughtfully structured life insurance plan can bolster your own financial security, finance your children's education, and help preserve your estate for its beneficiaries.

Mind you, not all life insurance policies are created equal. Term life insurance provides only a death benefit, which diminishes as the policyholder ages. Thanks to generally affordable premiums, carrying a term life policy can make sense during your younger years, when the beneficiary payout would be highest. However, term life offers no real tax savings or wealth protection over the long haul.

Only permanent life insurance can provide these advantages, and it, too, comes in multiple forms. Developing a sound life insurance strategy begins with understanding the options.

The Difference Between Whole & Universal Life

The precise terminology varies from one insurer to the next, but in general, permanent life insurance policies are classified as either whole life or universal life. Both types have two components: the actual insurance portion, which provides a guaranteed death benefit (also called the policy’s face value), and a savings plan that builds cash value over time. The distinctions between whole and universal life lie in the premium structure, the nature of the death benefit, and the ways in which cash value accumulates.

The cash value of a whole life policy comes directly from paid premiums and grows according to the insurer’s preset formula. Both the death benefit and premium amounts are typically fixed, although the plan can be structured so that instead of accumulating value, the cash portion of premiums is used to buy additional coverage. In short, whole life offers very low risk and high stability, with slow and limited growth.

A universal life policy focuses a little more on growing the savings side of the ledger. For some policies, cash value grows in step with current interest rates. Other universal life plans, called variable plans, replace the traditional savings component with an investment fund or portfolio. These plans introduce an element of risk, but also the potential for greater growth.

A universal life plan may also have flexible premiums and benefits. For these variable plans, the policyholder may choose to pay more or less in premiums, or after a time, not pay them at all. The death benefit adjusts accordingly.

Using Your Policy’s Cash Value

You can draw on the cash portion of a permanent life insurance policy at any time, and for almost any purpose. Most commonly, insurers treat these withdrawals as loans, charging interest on the repayment that restores the policy’s full value. The main advantage a life insurance withdrawal has over a traditional loan is repayment flexibility. Essentially, the money is paid back when you are willing and able.

Alternatively, you can choose not to pay back a withdrawal from your permanent life plan at all. The result will be a lower death benefit, but that may be fine if the policy’s standard payout would exceed your family’s needs.

Regardless of which approach is taken, do not be too cavalier about how much cash you pull out of a life insurance policy. Most insurers require policies maintain a minimum value. If the plan’s value is drawn down below that threshold, you may have to pay higher premiums to preserve the death benefit, or worse, the policy could lapse altogether. The potential consequences of such a lapse include losing several long-term tax advantages.

Generally, as long as the amount involved does not exceed the amount paid in premiums (the basis, in tax jargon), cash withdrawals can be taken tax free. Savvy policyholders have found many uses for these withdrawals.

1.) Future College Costs for Your Newborn Child

With the possibility of tax-free growth and withdrawals, a permanent life policy can nicely supplement other plans to pay for your children’s education. This use of life insurance has gained popularity in recent years. To maximize the benefit, the policy should take effect shortly after a newborn’s arrival. Permanent life plans typically take at least a decade to build up substantial cash value. They also get more expensive to obtain as you age.

Unlike traditional college savings arrangements like Section 529 plans and Coverdell ESAs, a permanent life policy places no restrictions on how the policyholder uses withdrawn funds. Hence, no harm done if your offspring choose a life path other than higher education. Of course, those other savings plans have their advantages as well.

2.) Various Living Expenses

The freedom to use withdrawn funds however you see fit opens up a world of possibilities for life insurance to help policyholders and their families build better, fuller lives. The ability to obtain cash quickly without complex loan applications, and to pay it back on your own schedule, makes permanent life a versatile tool to handle any financial curveball the world throws your way.

For example, policyholders can use permanent life cash value for unanticipated major home and auto repairs, or as a short-term loan while awaiting a property insurance settlement after a disaster. It can also provide a reassuring safety net for covering living expenses late in life.

Wealth Preservation and Estate Planning

After clearing all of life’s hurdles, the assets you’ve worked so hard to obtain must then endure another gauntlet when you are gone. One of the great challenges in wealth preservation remains minimizing asset loss to estate taxes.

The current IRS lifetime exclusion of over $11.5 million (over $23 million for a married couple) keeps many moderately sized estates in the clear, but once that threshold is crossed, taxes pile up quickly. Furthermore, unless Congress acts to extend provisions of the Tax Cuts and Jobs Act, the exclusion will be reduced by more than half after tax year 2025. Many states also impose property transfer taxes of their own, often with a lower exclusion.

Permanent life insurance offers unique advantages in minimizing or avoiding estate tax impacts. For starters, beneficiary payouts are generally not subject to income tax, so these payouts provide heirs with immediate cash at a stressful and bewildering time. Even better, by setting up a life insurance plan in the right way, you may be able to move a sizable portion of your assets out of Uncle Sam’s reach indefinitely.

3.) Probate, Final Expenses, Tax Minimization, and Business Succession

Even if you set your heirs up very well for the future, they may still struggle with expenses when you pass away. A financial advisor can help protect your assets from the long ordeal of probate. However, your home and some illiquid investment holdings may still be difficult to convert to cash.

The death benefit from a permanent life policy goes directly to named beneficiaries, with no need for probate and, in most cases, no income tax impact. Therefore, heirs can put the funds to immediate use for funeral costs, paying off debts, or any other expenses they encounter while settling your affairs.

In cases where an estate tax hit cannot be avoided, a permanent life insurance policy eases your loved ones’ burdens by providing ready cash to help cover those taxes. Even better, a cleverly structured insurance plan may help them avoid tax impacts altogether.

4.) Who Should Own Your Life Insurance Policy?

To achieve the highest level of wealth protection, consider separating your permanent life policy from the rest of the estate. For example, the policy can be structured so that your beneficiaries own it instead of you. Another—and for many investors, better—option is to create an irrevocable life insurance trust (ILIT). With this setup, the trust owns the policy, not you, so the policy does not count toward the estate’s taxable value.

For some accredited investors, an ILIT with private placement life insurance (PPLI) offers one of the most sophisticated tax-free investment growth and wealth preservation strategies available today. Funds contributed to a properly structured PPLI trust are protected from taxation indefinitely, providing a legacy of tax-free growth.

5.) Funding Your Pension Plan Using Life Insurance

Permanent life insurance also provides opportunities for tax-savvy use of a defined benefit (DB) pension or retirement plan. While DB plans have fallen out of favor in some financial circles, they remain one of the few avenues for small business owners to set aside tax-protected funds for retirement without running up against restrictive IRS contribution limits.

By setting up a permanent life policy within your DB plan, premiums can be paid with a portion of plan contributions. When the time comes to terminate the DB plan because it has reached its full value, an ILIT can be created that purchases the life insurance policy, protecting the death benefit for your heirs.

Just keep in mind that a vast web of regulations governs the creation and use of DB plans. These rules limit the percentage of plan contributions that may go toward life insurance premiums, the insurance policy’s face value, and the allowed uses of its cash value when the DB plan terminates.

6.) The Business Pre-Nuptial

The death of a business owner creates special challenges for estate resolution, especially if the business in question has several majority-controlled owners. As I discussed in a previous article, a buy-sell agreement provides a clear roadmap for business succession. These agreements often call for a buyout of the departed partner’s share, which in turn means the remaining partners will need a substantial amount of cash on hand.

Once again, permanent life insurance offers a clean, simple, tax-friendly solution. Typically, the buy-sell agreement specifies that when a company is owned by multiple individuals, the owners take out permanent life policies on each other (that is, partners A and B both own policies insuring partner C, and so on). The policy’s death benefit provides the cash capital needed to complete a buyout, preventing the company from falling into the wrong hands.

Conclusion: Protection and Growth in One Package

People generally think of insurance solely as a financial guardrail, and to be sure, many types of insurance serve only that purpose. Permanent life insurance is a different animal, however—equal parts protection against calamity and investment tool for a brighter future. A carefully crafted policy not only recognizes the value of your life, it adds to it, while you walk this Earth and long after.

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Harvey Bezozi: As one of the most knowledgeable and well-connected tax & accounting professionals in the world, Harvey Bezozi's mission as a CPA and CFP ® is to provide concierge-level work product and service, along with seamless communication, high energy, and a super-positive attitude. Located in Boca Raton, Florida, Bezozi has been in business since 1994, and serves clients in all 50 states and internationally. More information can be found at YourFinancialWizard.com.

© 2021 Newsmax Finance. All rights reserved.


HarveyBezozi
While most people recognize that life insurance provides general peace of mind, they often underestimate the tax and financial advantages the right policy has to offer.
life insurance, college savings, home repair, auto repair, wealth preservation and estate planning
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2021-57-27
Wednesday, 27 October 2021 04:57 PM
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