"Whole Life Policy As Tax Advantage "

Published in InsuranceNewsNet by ProQuest Information and Learning Company

MAKING CENTS

One of the most controversial topics in the financial planning world is the use of life insurance

as a way to accumulate cash savings. Whole life insurance has been sold by agents for

decades as the lowest long-term cost of insurance along with a forced savings account. The

other side of this argument is to buy term insurance, and invest the difference.

I once favored the "buy term and invest the difference" approach. But I have seen very few

people who have stuck with the program and actually built that robust investment account.

Life insurance is primarily a tool to have a lump sum of cash at someone's death to provide for

loved ones. For most, the death benefit is the primary motivator. But for many wealthy

investors, accumulating cash inside a whole life policy has great appeal.

Wealthy, for purposes of this discussion, means that someone has more money than they

need. Their basic needs, fun activities and legacy plans are amply funded by their nest egg and

overall net worth. Their cash flow is stable and consistently well in excess of their cost of living.

If this profile does not fit you, then using life insurance as a savings vehicle should be a very

low priority for you.

Why is accumulating cash with life insurance so popular with the wealthy? First is the reality

that their next dollar of savings is not likely ever to be needed. It is frequently excess savings

that is likely to end up in the hands of the next generation.

Next is taxation. Traditional cash savings generate annual interest that is taxable. The interest

accumulating inside a whole life insurance policy is not taxed while accumulating. If the owner

of the contract dies and never gets to the cash accumulation, it all passes income-tax free to

the next generation.

Net returns are also a factor. Today's traditional savings vehicles have a very low rate of

return. The cash buildup inside a whole life policy may be higher than what you may get from

a CD. The potential returns from the life policy are twofold. One is the eventual death benefit,

which a CD doesn't offer. The second is the actual interest rate on the cash value buildup.

To properly take this approach, the owner should maximize contributions to the contract. Cash

accumulations inside whole life policies were such a great deal for tax planning that the IRS

actually limits just how much you can invest inside these contracts. To make it work best as an

accumulation tool, you need to contribute right up to the limit imposed by Uncle Sam.

Universal Life Insurance

Universal Life Insurance

Universal life insurance (UL) is a form of permanent life insurance just like whole life insurance. Unlike a whole life policy however, a universal life policy is a flexible premium life contract. This means that a universal life policy will pay for itself out of the policies' cash value, if enough present, without any direction from or loan fees to the policy holder. (A whole life policy can pay for itself, if set up properly at issue, but the policy owner needs to request from the issuing company, at each billing cycle, that the whole life policies' dividends pay the premiums due.)




Just like whole life coverage a universal life policy will build cash value on a part of the premiums paid into to the policy. The rate of growth of the cash value depends on the investment history of the issuing company. The amount of premiums paid into a UL that is credited with a return depends on the net amount risk to insurance carrier. The net amount at risk is the difference between a UL's cash value and the net death benefit. For example, if you were to purchase a UL policy for $250,000 at age 35, then the costs for year 1 would be based on an annual renewable term (ART) policyinside the UL contract. The costs for a term policy for $250,000 on a 35 year old happened to be $200 for the first year and the policy holder paid $1,000 into the policy. So, the additional $800 of the premium paid into the UL was credited with a return based on the issuing companies investment history for that year. In year two the net amount risk to the carrier is reduced by the amount of cash value in the contract, in this example the insurance company paid a 7% return on the remaining $800, crediting $56 dollars to the cash value. The new net amount at risk to the insurance carrier in year 2 is $250,000 - $856 (the cash value + the prior years return) = $249,144. This process compounds annually and can really add up fast. This will reduce the net amount at risk, the cost of insurnace and fatten up the policies' cash value. Just like whole life insurance, a UL policy builds cash value on a tax-free basis and can even be accessed tax-free if done correctly. The annual renewable term policy that is the "chassis" of the UL does ratchet up each year with your age, this allows the insurance carrier to offset the risks of an aging group of policy holders, but these increases in age considerations are offset by the cash value building and the net amount at risk reducing. The morale of this story is to find a good agent that can explain the moving parts inside a universal life policy and that will review the policy regularly with you. A UL policy that is set-up correctly is a very powerful cash accumulation and tax-advantaged tool. The death benefit is tax-free and can be much higher than the cash value in the contract.




Listed below are the different forms of UL coverage:




Current Assumption Universal Life (UL) - explained above, credits the policies' cash value with a fixed interest rate that is on par with market interest rates. A good current assumption UL will have a floor of guaranteed interest, to make sure that some kind of return is realized each year. For example, a current assumption UL that we recommend today has a guaranteed rate of 3%, but is currently crediting 2010 low interest rates of 4.5%.


Indexed Universal Life (IUL) - participates in market indicies, one of the most popular is the Standard & Poor's 500. The S&P 500 is an indicie of 500 of the largest capitilized companies traded on the New York Stock exchange and the NASDAQ. An IUL policy is credited with the growth of the indicie that it is attached to, subject to a cap rate. (E.g.- If the S&P 500 increases 20% in a year and the policy cap is 12%, then the policy is credited 12%.) Just like a current assumption UL, a IUL usually has a floor, or guaranteed rate of return during the negative years. An IUL that we recommend today has a 12% cap rate and a 1% floor.


Guaranteed Universal Life (GUL) - is a guaranteed UL product. Most GUL's are not designed to build much if any cash value; this keeps the premiums lower. As long as the policy owner pays the premiums as scheduled the death benefit is guaranteed to the age illustrated or the policy's maturity date. We currently recommend a GUL that has no cash value and premiums so low, that we refer to it as "term till death".

Benefits of Permanent Life Insurance

1. Tax-Deferred accumulation of policy cash value
2. Avoidance of 10% tax-penalty on withdrawals before 59 1/2 on qualified plans
3. FIFO (First in-First out) tax treatment on withdrawals = tax free withdrawals up to amount paid in.
4. Tax-Free death benefit to beneficiaries
5. Death benefit in excess of policy cash value
6. Death benefit avoids probate