Why Do the Rich Buy So Much Life Insurance?
September 1, 2014Comments
Before answering the above question, be assured that the information in this article works perfectly if you are worth $3 million or $333 million.
Now the answer: The tax law creates a special tax-free environment just for life insurance. This law provides everyone with an easy to create tax-free wealth. Your opinion of life insurance as a tax-advantaged investment will change when you learn the difference between the math (which follows) in a taxable environment as opposed to a tax-free environment.
Is $1 Million a Lot of Money?
In a taxable environment, more than you think. Can you guess how many dollars you must earn to leave your family $1 million after taxes? Try this:
You earn 2.78 million, minus the income tax (state/federal) on $2.78 million at 40 percent ($1.11 million) = $1.67 million. Then subtract the estate tax on $1.67 million at 40 percent ($0.67 million) and the balance to the family is $1.0 million. The tax collector gets $1.78 million, your family $1 million.
However, properly structured insurance will beat this tax monster at every turn.
The Law that Facilitates Magic Tax Tricks
1) Insurance premiums are deductible for estate-tax purposes. For example, in a taxable environment the IRS pays 40 percent of the premium. Suppose you pay $500,000 in premiums (from the day you bought a $2 million policy to the day you die). The $500,000 is gone, and can’t be taxed by the estate-tax monster. Result: If you had not bought the policy, your family would have received only an additional $300,000 ($500,000 less $200,000 of estate tax).
2) During your life: Your cash-surrender value (CSV) increases a bit each year as you pay the annual premiums. Sometimes the CSV exceeds the total premiums paid. All increases als are tax-free. You can borrow the CSV, called a policy loan. The receipt of such a loan is tax-free. If loans are not repaid during your life, they will be repaid at your death out of policy proceeds—also tax-free.
3) At death: The excess of the death benefit (say $1 million) your heirs receive over the amount of premiums paid (say $250,000) is tax-free. The excess of $750,000 ($1 million minus $250,000) is a clear profit, but every dime is income tax-free.
The $1 million death benefit, if properly structured, is tax-free —no estate tax. But be warned: if not correctly structured, the estate-tax monster will reap $400,000 in tax for every $1 million of death benefit.
