Why Do the Rich Buy So Much Life Insurance?September 1, 2014
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.