During the recent AALU conference in Washington, D.C., fellow advisors gathered to discuss one of the most pressing issues facing our industry today: maintaining the current tax structure of life insurance. Generally, income tax-free death benefits, tax-deferred cash value growth and tax-favored access to cash values through withdrawals and loans are important characteristics of a cash value life insurance policy1. So why has our government allowed such favorable tax treatment for so long?
The primary purpose of a life insurance policy is to provide a financial benefit to the policy beneficiaries upon the death of the insured. The cash value of permanent policies may provide certain lifetime benefits, too. Without the benefits provided by personally owned life insurance, it has been argued the government would incur costs that would far outweigh any benefits received by taxing life insurance.2 The tax benefits associated with life insurance reflect the acknowledgement by Congress of the important financial protection life insurance provides.
Should our clients be worried about their existing policies?
In the past, major tax changes in the insurance industry have allowed for existing policies to be “grandfathered” into the tax treatment that governed the policy at the time the policy was issued. New regulations primarily impact new policies or sometimes new money put into the contract or other material changes to an existing policy. We saw this back in 1988 with endowment contracts.3 This does not mean that Congress could not change the taxation of existing policies if they found it necessary. Proposals have been considered for some time that would result in less favorable tax treatment of life insurance, including a tax on the inside buildup of cash value or taxing loans as earned interest.
Many who advocate for life insurance tax reform consider life insurance as an investment that should be taxed accordingly. However, the reality is life insurance is a risk management tool, which provides financial protection in the form of a death benefit upon the death of the insured. In addition, cash value life insurance offers certain lifetime benefits and can be a useful asset in a financial portfolio. It’s important to stay involved and make sure Congress hears our voice.
It’s also important to assure our clients that regardless of possible future regulations and changes, when a death benefit need exists, they are doing the most responsible thing for themselves and their families by owning life insurance.