• Tax-favored growth: As tax rates rise, the value of every dollar in your investment portfolio falls, making income tax-deferred investment options a critical component of retirement planning. Returns on permanent life policies grow untaxed and, when properly structured, may be accessed untaxed, and provide an income tax-free death benefit.
• Greater growth potential: VULs are structured to allow the cash value of the policy to be invested in actively managed subaccounts that mirror mutual funds. Like many 401(k)s, the investment options available are vast, providing opportunities for greater diversification and long-term growth. With a long-term average rate of return between 6% and 8% (net of costs and fees), VULs benefit from the strength of the market.
• Funding flexibility: Unlike vehicles such as Traditional IRAs, Roth IRAs, Qualified Plans, and HSAs, there are no contribution limits on permanent life policies, as long as each policy complies with TEFRA/DEFRA regulations. Thanks to recent changes in the law (Section 7702), the allowable amount that can be contributed to the savings component of these policies has been increased as of January 1, 2021. This makes overfunded life insurance more attractive for affluent investors and small business owners in need of an additional tax-mitigation strategy.
• Asset protection: In contrast to trusts and other investment vehicles, principal held in permanent life policies is fully protected from any legal claims by creditors. And unlike domestic asset-protection trusts that require the assistance of an attorney and charge an annual asset management fee, they can be structured by a licensed life insurance professional at a much lower cost. In addition, policy principal does not reduce your Social Security and Medicare benefits, and death benefits are distributed tax-free.
• Penalty-free distribution prior to age 59½: Permanent life policies offer near-immediate access to assets with no tax penalty. This tax-free liquidity is particularly valuable in the event of a disability, to fund early retirement, or to fund personal and business expenditures. Policies can also be structured to offer policyholders the option to buy property, cars, and other large purchases from themselves while retaining unlimited access to policy principal.
In light of the national debt escalation combined with the economic impact of the Covid-19 pandemic, it seems unlikely that tax rates will remain low in the future—especially for high-net worth clients. As a result, it is important to put a strategy in place to help mitigate taxes on distributions from pre-tax accounts in retirement.
Speak to your clients now about the tax-mitigation potential of overfunded life insurance. For those that are interested, proper design is essential to ensure efficient growth of the policy’s cash value. If you don’t have detailed knowledge in this area, it is important to work with an independent and licensed life insurance professional (CLU, ChFC, CFP) who understands the complexity and features of permanent life insurance contracts, as well as applicable IRS tax rules (TEFRA and DEFRA).
Gary A Borowiec, CLU, ChFC, RFC, LUTCF, CLTC, RICP is managing partner of Madison & Main Advisors, an independent planning firm based in Madison, NJ. An independently owned and operated Member Firm of M Financial Group, Madison & Main specializes in investment tax planning and wealth transfer.