When to Recommend Life Insurance Based on Its Tax Advantages

Life insurance is more than just a way to pay for outstanding debts and end-of-life expenses. Many use it to provide money to their loved ones after they pass. You can even take it a step further and recommend life policies for their wealth transfer tax benefits.

These days, individuals can transfer their assets to their heirs using several different means. Annuities, 401(k)s, IRAs, trust funds, cash accounts, and other investment vehicles all allow the owner or account creator to designate beneficiaries. However, if your client has the money and is in relatively good health, they may want to purchase life insurance, specifically single premium whole life, to forward their wealth to the next generation.

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Let’s explore when you should consider marketing life insurance to clients for the sake of its tax benefits.

Your Client Has Large Lump Sums in Savings Accounts

To use life insurance as a wealth transfer tool, your client needs to have wealth. We generally recommend they have liquid assets equal to at least $5,000, since this is usually the minimum premium for a single premium whole life product.

Single premium whole life (SPWL) is a great product for individuals who want to capitalize on the wealth transfer tax benefits of life insurance. Here’s why:

  • The policy is paid for and the death benefit is guaranteed after one premium payment.
  • The single premium payment can lead to potential savings over an annual premium payment.
  • The policy accumulates cash value, which is accessible to the policyowner and grows tax-free.

One particular instance when you could suggest an SPWL policy to a client is if they tell you they’re maxing out their contributions to their IRAs or 401(k)s. You could also recommend purchasing an SPWL policy to a client if they have reached the age at which they must take required minimum distributions (RMDs) from their retirement plan. Your client can use their “overflow” or RMD money to purchase an SPWL policy. Similar to 401(k)s and IRAs, an SPWL policy would allow your clients to build cash value on their money tax-free. It would also allow them to shift any “extra” wealth they may have to their heirs more easily.

Your Client Wants to Pass Money on to Heirs or Charity

Investment accounts IRAs, 401(k)s, and annuities can be a great way to save for one’s golden years — but a “taxing” way to leave money to family, friends, or charity. Through these products, the transfer of funds from the deceased to designated beneficiaries may be subject to delays, as well as dues to good old Uncle Sam.

If an individual places funds into a bank account, IRA, 401(k), annuity, or even a life insurance policy, AND names their estate as the beneficiary, the account or plan will likely have to go through probate when they pass. On average, this process takes six to nine months to complete, according to the American Bar Association.

Once that is over, the estate and any other assets for which the deceased did not name an heir will likely be subject to the federal estate tax and maybe even a state inheritance tax. Presently, the estate tax, or “death tax,” affects estates that exceed $11.4 million per person or $22.8 million per married couple. Any amount over those limits is generally taxed at the top tax rate of 40 percent. The heirs may then be responsible for paying a tax, determined by the deceased’s state, on what they inherit. Currently, only six states (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania) have an inheritance tax.

Additionally, after inheriting 401(k)s, IRAs, and annuities, all named or unnamed-but-legal beneficiaries will usually have to pay federal and state income taxes for some, if not all, of the money. Here’s where life policies shine: life insurance proceeds are generally income-tax free.

SPWL policies typically pass the death benefit to beneficiaries completely tax-free. On some policies, interest building inside the policy increases the original death benefit and that interest is taxable, but the original death benefit is not. As long as your client names a designated beneficiary other than their estate, then the beneficiary of ANY life policy should not have to pay taxes on their inheritance. The only snag could be if your client establishes an incident of ownership on their life policy. In this situation, the life policy may be considered part of your client’s estate (even if they have named a beneficiary) and liable to estate and inheritance taxes. Be sure to discuss these situations with your client.

Your Client Can Maximize Their Legacy and Minimize Tax Burden

Let’s say you have a client named Sue who has $50K in a savings account that she is planning to bequeath to her daughter.

If that money remains in Sue’s bank account, upon her death, it will be made a part of her estate and taxed, rather than go directly to her daughter. However, if you help Sue take that money and purchase an SPWL policy, her $50K will likely purchase a $75K death benefit (or higher depending on her age at purchase). She then has the ability to pass her funds directly to her named beneficiary tax-free. And if Sue needs some of the death benefit to help pay for any long-term or critical illness-related care she may need in the future, she may be able to access it tax-free, depending on the policy.

With a little fact-finding, you can uncover “hidden” funds and let clients like Sue know that they can use life insurance to better plan for the future.

Life insurance’s favorable tax treatment makes it one of the safest products in which individuals can stash their extra cash. Do your clients know everything a policy can guarantee?

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Editor’s Note: A modified version of this post was previously published by Producers eSource on March 13, 2018. This post has since been updated to include information relevant to 2019.

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