There are several strategies you can use to pass assets to the next generation while mitigating taxes. This article will focus on life insurance for wealth transfer as it’s one of the most efficient. Life policies immediately create a fully valued tax-free asset upon first premium receipt.
Our clients ask about cost effective ways to maximize the distribution of assets to their spouses, future generations and favorite charities. There may be no better asset class than life insurance.
There are many reasons, but the most common ones are cost and tax avoidance. With life insurance, you are paying pennies on the dollar. When you consider that a healthy 60 year old can create a $100,000 death benefit with a one-time deposit of around $25,000, the numbers make sense.
And of course, life insurance proceeds are income tax-free to beneficiaries. Additionally, these policies can be structured to avoid federal estate and state inheritance taxes. There are very few asset classes that can do this much. That’s why life insurance policies are used so often in estate planning.
The two most common types are whole and universal life insurance. You rarely see term life insurance used as these types of policies have a defined ending point. A policy that expires after a 10-30 year term will have no benefits if the insured is still living.
Whole and universal policies each have their own advantages. Whole life policies are more conservative and generally offer more cash value. Universal life policies may have little cash value, but can create much larger death benefits with smaller premium deposits. And both types can be guaranteed to cover the entire life of the insured.
Single premium life insurance is an often used strategy for wealth creation and transfer. With this type of life insurance, a single premium is deposited creating an immediate death benefit. The death benefit is guaranteed until the owner passes away. Typically single premium policies provide larger death benefit amounts when compared to lifelong or multi-pay policies.
Multi-pay or lifelong policies are just what you would guess – policies that are funded over a set number of years or a lifetime. These types eliminate the need for large upfront sums of money and can have additional tax advantages to the insured. One size does not fit all.
Single premium life insurance can also benefit the insured during his or her lifetime. The cash value in a fully funded policy will grow quickly and can provide income to the if needed. In turn, the owner can also surrender the policy for its cash value. Other policies have an option of an accelerated death benefit that can be to pay for long term care expenses.
By using this rider, the owner can access their death benefit while living. It might be used to cover long term care expenses or other costly healthcare needs. Many policies include an accelerated death benefit at no charge to the owner. This allows consumers to transfer wealth while also accounting for future healthcare costs.
Many elderly consumers feel that they are not healthy enough to purchase life insurance. This is not always true. Simplified underwriting allows many seniors to qualify for life insurance. With simplified underwriting, there is no physical or blood work needed.
So long as the proposed insured can answer no to a few health questions, medical underwriting can be done with the application and a quick telephone interview. The fact is single premium life insurance is not difficult to purchase. Those who feel they are in extraordinary health can choose to go through advanced underwriting and may qualify for increased insurance benefits.
Certainly the advantage of life insurance over an annuity, a savings bond, a certificate of deposit or other investment is its favorable tax treatment. The entire death benefit is passed income tax free to the beneficiary. However, the death benefit can count toward the gross value of an estate for estate tax purposes.
To avoid estate taxes, some policies are owned by the beneficiaries or an irrevocable life insurance trust. It is crucial to work with a knowledgeable agent and attorney if estate taxes are a concern.
Often single premium life is considered a modified endowment contract or MEC by the IRS. The policy can be taxable to the owner if gains are withdrawn- just like an annuity or savings bond can be taxable to the owner. If the owner is under the age of 59 ½ the IRS can access a 10% early withdrawal penalty. Thus these policies are best utilized when the funds are likely not needed in the immediate future.
In conclusion, life insurance is a safe and dependable asset for many families. Life insurance is especially valuable due to the favorable tax treatment and guaranteed returns associated with these policies. It is important to choose a well-rated company and an informed advisor to select the best policy for your wealth transfer needs.