In prior blogs, I answered the question in two different ways: 1) “When others are relying upon you the most“, and 2) “When you can get it.” For both, I used term, or temporary, insurance as the solution.
In this installment, we’ll explore a third and final answer in three parts: “When you realize that longevity, flexibility and tax-preferred treatment are important aspects of your financial life.” This time, I’ll be using whole, or permanent, life insurance to illustrate.
Let’s take these one at a time:
Longevity. The way this works is you have insurance that is guaranteed to last the rest of your life as long as you pay your premiums. And you’ll never have to worry about how or when any change in your health will change the amount of premium that you pay.
The reason many of my clients like this is because insurance is the most efficient way to leave money to anyone or anything. Chances are that when we are older, we are going to care about someone or something. There is no asset in this world that creates instant, income-tax-free liquidity other than life insurance.
Let me say that again: There is no asset in this world that creates instant, income-tax-free liquidity other than life insurance.
Understand, though, that this is not a short-term place to put money. I would plan not to use this money for 12 to 15 years, and the strategy works best if you wait until at least 20 years or more. In the beginning, the difference between what you put in and your cash value is going toward getting you permanent life insurance.
Flexibility. When you place money inside an insurance contract, the sense of safety and comfort you gain allows you to leverage other assets. It allows you to take equity out of real estate; it helps you with estate taxes; it allows you to spend down your 401(k) and not feel guilty.
The cash value is also credit-proof and lien-proof. That means if you have kids that apply to college, the schools do not use this as a countable asset. Or, if someone falls on your property, they can’t get to it.
Down the road when you take cash out, you have the ability to withdraw money tax-free. This is different than everything else that is available to you.
My most successful clients realize that their thoughts on risk are going to evolve over time. A 30-year-old looks at risk a lot differently than a 50-year-old. Once there is cash value in this plan, it is guaranteed not to go down in value. By design, as you get nearer and nearer to retirement, you have more and more wealth in a conservative place, exactly as you’re supposed to.
Tax-preferred treatment. First and foremost, the death benefit from a life insurance contract pays income tax free by operation of law. But more than that, the cash value grows on a tax-deferred basis. Each year you are compounding interest without having to pay taxes on it.
From an investing standpoint, your 401(k) works great today. It lowers your current taxable income and grows on a tax-deferred basis. The problem is that it is tied up until you are 59½ years old, and when you take the money out, it’s all taxed as income. At that point, most of my clients have paid off their mortgages and their kids are grown. So they’ve lost their two biggest tax deductions. If this is their only place to withdraw money and they want to live off $100K per year they will have to pull out $170K to pay the taxes.
Because a life insurance contract works much like a tax shelter, the cash value has grown all the years that you’ve funded this plan and you’ve never had to pay taxes on the growth. And when you choose to take money out, you can access it tax-free, avoiding income and capital gains taxes.
Think about it this way: In the beginning of the strategy, you are moving money from one pocket to another pocket, with the difference being you are moving it from a taxable world to a world where you can avoid paying taxes ever again.
If you’d like more information about how this strategy might work for you in terms of longevity, flexibility and tax-preferred treatment, please feel free to give me a call on 617-619-0294 to schedule an appointment.