When you read or hear the words tax protection, it probably does not evoke images of using the entire life insurance. But whether or not your whole life is really a tax situation depends on how you define it more than anything.
It is not a tax protection in any of the more shady ways that people discuss tax protection. But it really fits in with something similar to a TSA (tax-protected annuity) in a more general sense.
If you spend more than a few minutes cruising around your old one on the internet, you can find all sorts of interesting "information" about different tax homes. Since this site focuses on the use of life insurance, especially a lot of time and words written about the whole life insurance, I will take a look at how the whole life works as a tax protection.
Are whole life premiums deductible?
The first thing to deal with is the elephant in the room. One of the most common questions I have received over the last two plus decades of being a life insurance broker is a certain taste of "are my premiums for this entire insurance deductible?".
The short answer is no, they are not deductible. Your entire life insurance premium is paid in dollars after tax. For many people, especially those who own a business, this is a disappointing answer. I understand that I own one business, several in fact, and paying my life insurance premiums as a deductible expense is certainly appealing. Being able to reduce taxable income by deducting reasonable and customary expenses from gross income is one of the great benefits of being an entrepreneur.
But the IRS has decided and clearly written in many decisions and as part of the IRC that life insurance premiums do not fit the bill as reasonable or customary expenses to run a business.
The only exception to this rule is that an entire life insurance policy can be part of a qualified plan. This means that technically, your entire life insurance premium, in this scenario, can be paid in dollars before tax. How and why someone would do this is a long and complicated discussion. When this is done, it is usually done as part of a defined benefit pension plan.
And although yes, there may be potential tax savings, but these plans are quite complex and costly to set up and administer (think more than $ 20k to start and more than $ 10,000 per year to administer). Not to say that they are not a good idea, just that most companies will struggle to justify the cost of establishing such a plan, even if they really exist and can work well for the right situation.
Long-term tax deferral and the strength of insurance loans
The real application of whole life insurance as an effective tax haven for 99% of the population is to finance the policy with dollars after tax. Just pay the tax, set up your policy to get a budget-friendly (but stretch a little) premium amount each year and see the composite.
Of course, I assume you are buying insurance from a company that issues participating whole life insurance that has a long history of paying the policyholder's dividend. Most good insurances are issued by companies that have done and done well for over a hundred years.
And that your policy is designed correctly to maximize cash value in the coming decades. This usually means that you work with a competent life insurance broker.
I like to think we fit that description, our customers tell us. If you want to talk to us, please go here to our contact form and send us a message. We work with customers all over the country.
The best returns from an entire life insurance policy come from compensating the cash value over time. Yes, of course, you can access your cash value almost immediately if you want, but that's not our recommendation. In our experience, the best result our customers get is by financing the policy and forgetting it for a while. It takes some time to capitalize on your policies properly in a way that can give you self-sustaining momentum later in life when you want a tax-free income.
I have mentioned it before, but several years ago I met a guy whose father was an old life insurance broker. His father had foresight decades ago to fill in as much money as he could in entire life insurance policies.
Remember that this was a long time before anyone talked publicly about banking strategies or used whole life insurance as a pension income tool. Heck, he started this before the internet even existed. And now today he gets more than $ 200,000 a year from his policy and everything is tax free.
All the cash value he accumulated during that time has increased without paying any tax for that growth. And now through careful use of insurance loans, he can have a significant pension income without it being taxable. If this is the first time you've ever heard of it, I understand that it seems a little too good to be true, but it's real and people do it all the time. 19659002] Since you technically borrow the money through an insurance loan, the life insurance company lends the money. They use your accumulated cash value as collateral for that loan.
How to get your cash out of the entire policy tax free
The good news is that life insurance companies make it easy for you to get your money from your insurance tax free . To give you a little context here, I am talking specifically about the possibility of receiving a pension income from your insurance systematically every year.
Most people who finance their entire life insurance with a view to generating pension income will use a strategy that maximizes sustainable income. Generally, this is done by using what we call "withdrawals to the base, then take out an insurance loan"
In this strategy, you would first remove cash from your insurance all the way up to your total cost base. If you paid $ 250,000 in total premiums since you started the insurance, you would withdraw cash up to that number and then switch to insurance loans.
But you do not have to do it this way. You can also skip withdrawals on a cost basis and rely solely on insurance loans. Which option is better depends on your circumstances and the loan terms of your specific insurance, including the prevailing loan interest rate and current dividend.
And of course, in addition to having a systematic income plan for your insurance, you can take out a policy loan at any time you choose as long as there is cash value in the policy.
Many times, those who plan to use their pension income policy take out insurance loans and repay them several times during the years leading up to retirement. Our customers have and continue to do so, mostly to pursue other investment or business opportunities. When all cash value is your money, you can use it any way you want and at any time you choose.
Whole Life Tax Protection Summary
While whole life is not commonly used as a tool to protect income from taxes, it is an effective tool for protecting money that has already been taxed from future taxes. The analogy has been made that it is better to pay tax on your seed rather than your harvest.
It is a good idea to pay taxes now (when prices are probably as low as they will be in our lifetime) and protect all your cash values as you approach retirement (when rates are unknown) from whatever the prevailing rates at that time. These factors make the whole life insurance an effective tax protection.