As most people know, one of the best ways you can increase and protect your wealth is to reduce your tax liability. You are likely already familiar with saving in a tax-advantaged retirement account like a traditional IRA or Roth IRA. However, those accounts have contribution limits that aren’t high enough for higher-income earners preparing for retirement. You could always invest in a taxable brokerage account, but those come with an annual tax bill. Many people don’t consider one of the best secret weapons of tax-deferred investment vehicles: life insurance.
How Permanent Life Insurance Works
Life insurance is a contract between you and an insurance company saying that in exchange for a premium that you pay, they will pay a death benefit. Some are for a set time and some are permanent. Permanent life insurance means you maintain coverage as long as premiums are paid. For both kinds of life insurance, the death benefit is paid out tax-free, so the beneficiaries don’t have to pass any of it on to the IRS.
With permanent life insurance policies, you can build up something called cash value, which is like investment growth. The cash value accrues tax-deferred, just like the earnings in a traditional IRA or 401(k). The accrued cash value can be used to pay premiums or it can also be taken as a loan from the policy.
How to Use Life Insurance As an Investment
Life insurance is typically thought of as protection against the risk of premature death, which is true. That is the primary purpose of life insurance. However, that’s not its only use. It can also be used as an investment that grows tax-deferred and can provide income in retirement.
When you purchase a permanent life insurance policy, the premium is allocated to both the death benefit and the cash value. To use it as an investment, you want as much allocated to the cash value as possible. A good financial advisor can help determine the best way to structure the policy to meet your needs.
In retirement, you can take out the amount you paid in premiums (your tax basis) tax-free since the money had already been taxed before being used for premiums. Any withdrawals you make will count as the return of your tax-free tax basis until you have made up for all the premiums. Once you have exhausted your tax basis, you can borrow the cash value tax-free. Your life insurance policy can make you loans to supplement your income, and since they are not official withdrawals, you do not have to pay any taxes on them. In this way, you can create a tax-free income stream for yourself in retirement.
How I Can Help
To use life insurance as an investment, you need to have a properly structured policy in order to receive the maximum possible benefit in retirement. Also, you must strategize withdrawals carefully to avoid lapsing the policy. If you want to learn more about using life insurance to mitigate your tax expenses, we at Grace Wealth Management Group can help. With several decades of experience under my belt, I can answer your questions and help you determine if this strategy makes sense in your specific situation. Schedule an appointment here or call me at (949) 631-3840 x2 or email jbang@cfiemail.com to get started.
About Jim Peters
Jim Peters is an independent financial advisor and the founder of Grace Wealth Management Group, Inc., a full-service financial firm committed to helping people pursue their financial goals. With more than 24 years of experience in the industry, Jim combines his extensive knowledge with his genuine interest in helping people pursue financial independence. Beyond his experience, he is certified as both a Chartered Life Underwriter® (CLU®) and Chartered Financial Consultant® (ChFC®) professional, meaning he has advanced training and knowledge in financial planning and insurance. Based in Irvine, California, Jim specializes in working with individuals, families, and businesses throughout Orange County. To learn more, connect with Jim on LinkedIn or visit www.financialadvisorirvine.com.