How Life Insurance Can Help You With Taxes - Zupnick Associates

(by Jordan Johnson)

Thinking about how life insurance can help you with taxes? There are a few key advantages you can utilize both while you are alive and after you pass on.

There are also some steps you can take to ensure the death benefit in its entirety makes its way to your heirs without any sort of estate taxation, even if your estate is above the threshold.

How Can Beneficiaries Get a Truly Tax-Free Death Benefit?

While the heir of a death benefit does not usually incur any taxes on the receipt of the sum, the death benefit can still be taxed as part of the deceased’s total estate. 

The federal estate tax is applicable when the deceased’s estate is valued at more than $12.06m (for 2022), and some states have a similar state-wide estate and inheritance tax.

Here are some ways tax can be avoided when estate taxes may affect the death benefit:

  • Transfer ownership of the policy so it’s not part of your taxable estate.
  • Create an irrevocable life insurance trust to act as a tax shelter for larger estates.
  • Instruct the death benefit to be provided as a lump sum as not to incur tax on interest earned with the insurance carrier.
  • Ensure that gift tax is avoided by only appointing a maximum of two entities to cover the three roles of the policy.
  • Use a buy-sell agreement to get fair market value, in cash, for any business assets that heirs might not want to manage.

Can Having Life Insurance Help With Other Tax Issues?

Yes! There are a number of reasons why a life insurance policy can be an effective tax planning tool even when you are alive.

As permanent life policies like whole life and universal life have both a death benefit and cash value element, there are certain things you can do to make that cash work for you without incurring any taxes.

On top of this, other types of insurance can make your estate taxes less complex when you pass.

Whole Life Insurance Policies

Whole life is a type of permanent life insurance that should cover the insured for the rest of their lives – with certain tax advantages along the way.

This is because the cash value of any permanent life policy generally grows tax-deferred, meaning you won’t pay tax until you withdraw it. With whole life policies, the amount your investments return depends on how the insurance carrier invests your cash assets, but policies typically incur no losses. There are caps on the percentage increase on the investments, however. 

Here are some of the tax benefits of having cash inside a permanent life plan:

  • The death benefit is tax-free to the beneficiary, as usual.
  • You can create an estate with a policy designed for a tax-free life insurance retirement.
  • If you have college-aged children, you can use the cash inside a plan to pay for college expenses, which are excluded from financial aid considerations.
  • You can borrow against the cost of premiums you have paid into your plan without paying any tax.

Variable Universal Life Policies

Similar to a whole life policy, a variable universal life policy is permanent insurance with both a death benefit and cash value. 

Variable universal life affords the policyholder much more control over the investments made with their cash inside the policy, with zero caps on how much the investments can make and the risk of incurring losses.

That makes variable universal life policies an excellent place to invest cash after you max out any individual retirement accounts such as your 401k, as any movements of stocks, shares, or other investments within your portfolio are on a tax-deferred basis. 

Here are some tax considerations to think about when investing with universal life policies:

  • It’s a great place to invest after IRA accounts like the 401k.
  • There is no taxation on reallocations within the policy, such as when rebalancing your portfolio, saving you time on your tax return.
  • There are no caps on investment earnings, though losses can be made like holding any other stock.
  • Variable universal life policies can act as a tax shelter, and you can overpay into your policy to have more cash within the policy.

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