Who would
have ever thought that one of the most attractive tax deferred, cash
accumulating vehicles could be found inside a permanent life insurance
contract? Imagine that, insurance
policies that have outperformed the S & P 500 over the last 15 years with
respect to cash accumulation. If you
haven’t heard this concept, I strongly suggest that you educate yourself on all
of the benefits that you have been missing out on.
One of the
ways to accumulate cash within a permanent life insurance company is through an
indexed universal life policy. These
products allow for capped gains in the market while expelling any possibility
of losing a penny to market volatility.
This is possible through a concept known as annual reset. Annual reset allows you to earn a portion of
the market upside, while bypassing the market downside; usually over the span
of a calendar year. Added to which, with
this concept it is not possible to lose a penny of your money when the stock
market takes a hit. This is a philosophy
that many investors and businesses are openly embracing, especially with tax
advantaged withdrawals.
Since
indexed universal life (IUL) is a form of permanent life insurance, it is
subject to an accounting measure known as FIFO.
FIFO is an acronym in accounting known as first in, first out. This means that all of the principle that is deposited
into an IUL policy is able to be withdrawn before you are required to pay
ordinary income tax on the interest earned.
In other words, interest is only paid when all of the principle is
withdrawn. This is one of the only
financial vehicles that will allow for funds to be withdrawn without having to
pay the tax upfront. Most all other cash
accumulation vehicles require that taxes on your interest must be paid first
upon withdrawal, usually as ordinary income tax or capital gains tax (assuming
you’re lucky enough to have any return).
Let’s take a look at an example. John has an indexed universal life policy
worth $225,000, of which $40,000 consists of earned interest. Assuming that John makes his first withdrawal
on his policy in the amount of $50,000, he will not have to pay any taxes on this
withdrawal. Since the interest on the
policy’s cash value is $40,000, all of the principle ($185,000) will have to be
withdrawn before any taxes are due on the interest. These unique features are attracting
businesses by providing tax breaks they are currently not receiving.
Businesses
are using permanent life insurance as a vehicle that can accept deposits, while
simultaneously withdrawing funds that do not trigger a taxable event. This gives the business the advantage of
paying invoices while utilizing tax deferral.
Another attractive benefit is that they allow business owners to have
the comfort of knowing that their family’s interests are protected with an
accelerated tax free death benefit. Business
owners also have the capability of protecting themselves against the unexpected
passing of a key employee, while allowing that employee to accumulate funds (exempt
from market volatility) for future retirement needs. Many business owners realize that unforeseen
emergencies such as the death of their top salesman, or the death of an
executive, can be devastating to the bottom line both in the short term and the
long term. Costs associated with the
passing of a business owner or a key employee can cause a company to
collapse. These policies protect against
these concerns while allowing for tax free income (if properly structured) for
their income planning needs.
How can they
do this in a depressed financial environment?
Insurance companies offering permanent life insurance products have the
advantage of basing their long term goals on effective mortality tables. Every policy owner must complete certain
underwriting criteria in order to qualify for these unique benefits. Think of it as a substitute to good credit; the
analogy being, the healthier you are the better your policy should
perform. Since all policy owners are in
good health and are expected to live longer (usually able to reach the
mortality rates in life) the insurance company benefits from extended profits
due to their policy owners averaging a longer life.
As this
financial recession lingers on, tax deferred vehicles that can allow for both
tax deferral and tax advantaged withdrawals will take center stage sooner rather
than later. Policy owners who have been
able to take advantage of indexed universal life products over this past decade
have had the benefit of skipping over all of the down years while receiving
attractive moderate return on the upside.
Do you currently have a tax deferred vehicle that can allow for tax
advantaged withdrawals? If not, what is
your contingency plan against the threat of rising taxes needed to knock our
federal deficit back to a manageable level?
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