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The Tax Advantages of Whole Life Insurance

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Market conditions over the past couple of years have caused many people to begin to take a closer look at financial products that offer guarantees. As the values of equity portfolios have decreased during the recent downturn, insurance producers are faced with the opportunity to educate clients about using cash value life insurance as an asset.

While the primary purpose of life insurance is the death benefit protection, it is important to understand the advantages of guaranteed cash value accumulation. With the changing landscape of the economy, limitations to traditional investments, the shifting expectations of retirement, and the current and future taxation of investment vehicles, clients are often left wondering what options they have to meet their financial needs. A whole life insurance policy can be appropriately designed to meet many financial needs. These may include resolving financial issues related to accumulating, distributing, and transferring wealth – now and in the future.

In contrast to traditional investments, whole life insurance can be designed to provide clients with cash accumulation while still protecting them and their loved ones along the way. With no income contribution limits, tax-deferred growth and tax-favored distributions coupled with the protection of an income tax-free death benefit, this asset can be a powerful financial solution to meet client needs.

When talking to clients about which options are available, however, the tax treatment of assets in their portfolio needs to be discussed.

Future taxation

The impact of future taxation on accumulated assets in a portfolio can be problematic. Clients simply cannot prepare for not only what is known today, but what could also happen in the future. While it is impossible to predict the future of taxes, reviewing past trends can provide insight as to where we are in relative terms of taxation through the years. This is a common practice used for trending market returns, but seldom used to trend taxation. As taxes have a significant impact on assets in a portfolio, it is important to consider the effect potential taxes will have on assets. By allocating long-term savings to assets that generate tax-favored income, clients can help enhance their retirement lifestyle. The chart below gives the U.S. federal marginal income tax rate over the last 100 years.

Tax diversification

How much clients save and where they invest may be one of the most important decisions in the planning process. Market diversification is a fundamental investing strategy, but tax diversification is seldom a topic of discussion.

Examine the taxation of clients’ investments both now and in the future. The long-term outlook for investments could be hindered by an uncertain tax market. Traditional investment vehicles, such as qualified plans, have many advantages, but one major disadvantage is that earnings and pre-tax contributions are all taxed as ordinary income upon withdrawal. Personal investments are generally taxed at capital gains and dividend rates that under current law can be more favorable than those taxed as ordinary income, however they do not provide tax-deferred growth. Therefore, you may want to consider diversifying your clients’ portfolio not just from a market perspective, but also from a tax perspective, in anticipation of what future taxation might look like. Properly structured whole life insurance offers the opportunity to have tax-deferred cash accumulation that can be transitioned into tax-favored income via policy loans and withdrawals. Of course, loans and withdrawals will decrease the overall death benefit and cash value of the policy. However, when purchasing whole life, both the protection and value are guaranteed.

After discussing the tax treatment of different investments with clients, you will need to discuss the internal rate of return on the investments.

Internal rate of return

The process of internal rate of return (IRR) is used to determine the financial efficiency of any investment. IRR is the annualized percentage of growth inside an investment. When looking at life insurance as an asset, it is also important to consider the policy’s IRR.

When calculating the IRR of a properly structured whole life insurance policy, it is important to remember that it has tax-favored withdrawal and loan options.

This means that when comparing it to traditional forms of investing, you must calculate the tax-equivalent yield. To do this you need to incorporate the client’s tax bracket to determine the rate of return needed in a taxable position to earn equivalent income through an instrument like whole life insurance that allows income tax-free access to funds. Typically, the calculations highlight the impact of taxation on IRR and show that your client would have to earn higher rates of return on assets other than the cash values accumulated in the whole life insurance policy.

Whole life insurance can also be structured as a participating policy. Participating policies have the potential to earn dividends which can be applied to the cash value in the policy and may increase the IRR calculations.

The power of whole life

With these distinguishing characteristics, whole life insurance can be a powerful solution for many clients’ financial needs, providing life insurance protection in addition to a potentially valuable asset within your clients’ portfolios. Consider the benefits of whole life insurance when designing solutions to provide supplemental income, charitable giving, and other financial solutions for individuals and businesses. By understanding the power of whole life insurance, you and your clients can take a new look on life.

Gene Lunman is the senior vice president at MetLife. He can be reached at [email protected].


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