Insurance is typically exempt from tax because it’s a payout for loss. You insure your house or car - poof, bang - need another one? Imagine if the government dinged you for that replacement as “income”. Similarly, a life insurance payout is supposed to be a replacement for lost income and support. In today’s world, a million dollars may not be enough to replace the typical breadwinner biting the big one at 40 years of age.
Conservative nattering nabobs of negativism aside, how much do you have to pass on to the loved ones to pay taxes on an estate? IIRC from the last election hype, it was millions at least for estate taxes, unless they are actually completely gone nowadays. the only taxes payable on death are the ones you would pay if you did the same thing while alive, like sell the house, cash in your IRA (or Canadian RRSP) contents, etc.
The main point still being - if you did a good job of your retirement finances, why do you need insurance once the retirement fund is in place and the kids have left home? By then, the house should be paid off too. With today’s life expectancies, the kids should be past 50 and have their retirement finances already in place before they ever see your insurance. Worst case, the spouse gets $500,000 when she is so old she can’t count to 10.
Remember how the kids used to fight over who got the last piece of cake? Now imagine the fun when mama’s half-million is controlled by one kid and the others suddenly start wondering what’s been happening to it? Nothing like a good inheritance fight to bring out the best in people…
Life insurance retirement plans are known under a few other names, such as bank on yourself or 101 plans. There are several books on the subject. They are not a scam and are available only from licensed professionals.
While they may sound too good to be true, there are limits. There are some good books written on the subject such as “Tax Free Retirement” and Missed Fortune 101". The way to properly structure one of these is to fund it to the limit before it is considered a Modified Endowment Contract (MEC).
You can access the cash portion of these contracts as a loan. If taken as a loan rather than a withdrawal you can access this money tax free. Some of these contracts allow for the loans to come out of the general account of the insurance company leaving your money in your contract and still earning interest. Often the interest credited is higher than the interest charged on the loan creating and arbitrage in your favor.
They are still investment funds. Either they grow and make money like any other fund (yeah, right in today’s financial situation - zero growth) or the company will not have the money when you are needing it if they promise great growth.
If someine has (see post 18) $2,000 to $3,000 to dump into something like this, they can dump that same amount into a savings plan or an IRA and have $24,000 to $36,000 saved for each year. 3 or 4 years, $100,000 even if there is no growth. 10 years, quarter of a million. You don’t need life insurance if you can afford that. With that sort of disposable income, and no young dependants, you better already be set for life…
Una, my question upon seeing your post wherein you state that you have no dependents, debts, or financial obligations was – why do you have life insurance? I have life insurance because I’ve got kids. One policy terms out when the house is free and clear, and the other terms out when they’re adults. As an investment vehicle, someone in your position is better advised to stick to an IRA (or 401(k) when it’s available).
Concur - one might want to have insurance to pay their funeral expenses or the like, but with no dependents needing an inheritance, I wouldn’t bother.
Unless, that is, I wanted to hedge my bets against truly needing it in the future, when (due to declining health) I might have more trouble getting a policy.
And second the “reported for what” - while the person who posted may well be involved in selling such investment vehicles, the posting itself was in no way spam or in appropriate. It’d be the same thing as a Doper lawyer or doctor commenting on a legal or medical topic.
Rereading the thread: I can see one situation in which this might be worth doing: if you’ve fully funded your IRA / 401(k), but still want to save, tax-deferred (tax-free?) for retirement.
Would I suggest doing this in preference to an IRA/401(k)? No, I don’t think so. With the LIRP, you’re paying for actual life insurance in addition to the overage that’s being invested - so there’s money being spent, instead of saved. Yes, you get insurance, but it’s probably pricier than a term policy.
So if someone DID want to try the LIRP option, I’d think that getting the least possible amount of insurance would be the way to go.
MsRobyn’s already hit on most of what I could say. I no longer work there, but I did work for a large life insurance provider for 2 years. VULs are available, and their premiums are expensive. It takes a good amount of time to build up any sort of cash value, and that cash value is not backed by anything. As MsRobyn correctly said, they’re subject to market fluctuations, and can lose value.
And while any loans you take may be tax free (I can’t comment on this, I don’t remember whether loans are taxed), they are loans - a portion of the premiums that you must pay to keep the policy in force will be automatically applied to any loan value, reducing anything that’s shunted into the cash value. You can add more to pay off the loan quicker if you want, but I don’t think you can avoid paying it. Maybe - I’m not sure how premium payments are structured. There may be a risk that if you reduce payments by any amounts applied to a loan (to avoid paying anything towards it), you might not have the payment required to keep the policy in force, and then poof - the policy’s gone (but not your cash value, if any), and so no death benefit for your heirs (which is presumably why you bought it).
While I worked there, they were emphatic during training that life insurance is not an investment vehicle, and should not be thought of as such. (And it’s probably going to get worse because of the recent financial collapse.) With some careful planning, life insurance can help you reduce tax burdens, which is why they can be attractive for wealthy investors that have maxed out other tax havens. However, IMO most Americans don’t fall into this category.
In short, yes, you can, but the premiums required to keep the policy in force while building up that cash value are expensive, and other tax havens that might be available to you probably have better benefits.
These plans are not suitable for everyone. Also Fixed Products are more attractive than VULs as the cash portion can’t lose money because of market risk. All loans are tax free as loans are not income. Withdrawals of cash are distributions and any gains from the policy that are withdrawn are taxable as income.
Also there are funding limitations. These contracts need to be funded over years and are a long term vehicle.
Hey All,
Wanted to say that most people who purchase a LIRP do it because they have already maxed out their 401K contributions and IRA contributions. This is just another vehicle for those who want to save more to do so tax free. The tax benefits are the main draw to LIRP. The life insurance is just an added plus. The premiums due on our LIRP are about 10% less than the tax bracket we will most likely be in come retirement time. We also thought this was an excellent idea because who really knows how much the tax rates will rise in the future… the premiums are set and will not go up. Yes, there are some disadvantages, your money is tied up, but so is my 401K… and I have a lot more in it than my LIRP. But again, LIRP’s are mostly used by people looking for tax free investments, not insurance.
A quick FYI: someoone apparently registered just to post a link to a site that (I presume) sells life insurance, and their posting has rightly been removed, but the one thing they said that might be informative is this:
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I don’t know how useful that is to the main topic of the thread, but figured I’d repost that much in case someone finds it helpful.
I happen to actually have a life insurance policy, which was given to me by an uncle at birth - “fully paid”. I don’t know what the face value is, or anything else about it except that there’s some interest credited every year - 20 bucks or so - and also a similar amount that gets reported as 1099-R (retirement) income.
I am not trying to sell anything, but I do want to understand if this is real.
I do have their “provisional” policy at hand, and it does has verbiage for these points. I just don’t know if I should believe it.
With these caveats, here are the magical benefits. Are they really true or what’s the catch?
They say I can borrow money tax-free and have no repayment plan at all. Thus it’s a withdrawal, except it’s legally called a loan to keep it tax-free. Does IRS really allow “loan” that does not need to be repaid?
They say I can borrow from the full death benefit, not just from the built-up cash value. If I sign up for $2M death benefit, but only have $200K in the account after X years, I can borrow from the full $2M, while $200K keeps accruing. This is really puzzling to me.
Interest on these repayment-free loans is 1.5% if the loan was issued during first 5 years of the policy, 0% if issued thereafter.
I can borrow tax-free from full Death Benefit for all kinds of reasons - acute and chronic health problems, Long Term Care, to pay for kids’ college, Accelerated Death Benefit with 24-month window.
. If I can’t afford the premiums, they can decrease the death benefit, which will allow me to lower my premium and keep the policy in force.
. They promise that company monitors proactively MEC risk. It is allegedly easy to avoid getting caught by MEC simply by staying well below the overfunding limit.
. The investment has a floor of 0% and a Max of 14% Annual Return
. They claim that these benefits will be grandfathered even if Congress & IRS may eventually cut off this sweet deal because “Insurance companies have powerful lobbies and that most Congressmen and Senators have large LiRPs themselves.” I’m not making this up. This is a quote from today’s conversation with their commissioned agent. I think the main Insurance companies are not selling these (Prudential, Northwestern Mutual). Is this true? Makes me wonder if these giants know something I should know.
Can someone with relevant experience please comment? Your advice is much appreciated.
Ditto, Robyn. Except being a licensed insurance agent is only part of what I do. My main trade is the investment side.
LIRPs can be very good investments for the right person. I’m not saying that you are that person. Without sitting down with someone - you, that other guy, whomever - I couldn’t say whether it’s for you or not. But they’re not for everyone.
In terms of the loan ability, there are a godawful amount of riders/special provisions that can be written into the policies so a policy for one person might look entirely different (and behave differently) than a policy written for another person.
I can’t comment on any specific provisions here (I’m prohibited from doing so in any open forum) other than to say go carefully and sign nothing until you do understand it. But that should go without saying for any contract.
Well, that’s not always true. There can be life insurance with long term care or early benefit provisions that pay out in case of a diagnosis of severe illness that can allow for the tax-free payment of medical expenses without the demolition of one’s retirement plan.
But it’s true that, for someone without financial need, the utility of life insurance needs to be carefully examined.
I know that in Canada, using your RRSP (like a 401K or IRA) as collateral for a loan automatically cancels its tax-free status if the tax people catch you.
If the IRS decides that too many people are pulling this trick, they will simply decide that this plan is a fraud and cancel its tax-free status. I assume the logic is that an insurance payout is tax free. However, if essentially the insurance company is parking your tax-free investment then feeding it to you, and collecting a repayment “tax free” as insurance payout when you die - that may be interpreted as a savings plan.
After all, real insurance means they bet on a probability - they may make money on one customer and lose on another. Structuring loans so that the savings fund covers it - is just the opposite of an insurance bet.
But that’s the difficulty. As you can see happened with Canada’s “Income trust” fiasco, if the wrong interpretation of a rule costs the government too much, they may e-interpret the rules to plug that loophole.
You are correct – the plan appears to be a super-sized tax-sheltered savings plan wrapped inside an insurance policy. It appears more attractive than IRA/401k because a middle-class retiree’s income is taxed pretty heavily if all he has is IRA/401k distributions and Social Security payouts. This is my parents’ big headache and is one of the reasons I’m even looking into LiRP for me.
Another mentioned benefit is that it is protected from creditors in all states where insurance and annuities are protected, which is all states but 5.
Ironically, I did invest heavily in those Canadian “oil field income trusts” for many years. They provided incredibly high dividends and stock growth for years. Unfortunately I stopped keeping a close eye on them and missed the Canadian government’s crackdown. Sold most at a loss, but some are still in my portfolio and give off a modest dividend.
So I do worry – if IRS has already forced even the vaunted Swiss to open up some of their anonymous accounts, what chance will domestic LiRPs have once the world will stop buying our debt?
Well, as I think I stated, I can’t make suggestions here.
But I’m not seeing the connection between LIRPs and the lack of buying debt. Also, there’s very little sign that US debt is in any near- or middle-term trouble in terms of demand. That’s a sort of alarmism that TV pundits indulge and you should ignore.
Indexed Universal Life (IUL) is what you want. Locks in your gains because of the indexed strategy (you don’t lose your money/no risk), while Variable Universal Life (VUL) is in the market and much more risk is involved. IUL mirrors the S&P 500 Index. It has a floor of 1% and a cap of 13%. If the stock market crashes completely, you still don’t lose money, but your money doesn’t grow (which I’ll take any day of my life–Warren Buffet said…he has two rules: Rule #1 Don’t lose money Rule #2 Don’t forget rule #1). Plus, ALL of your gains are tax-free because of the death benefit. Because of that death benefit, your money is protected. You want lot of insurance because your cash value can exceed the death benefit…this let’s your money grow and you can dump money in as well. Cost of insurance may be higher, but the tax-free growth, rate of return, no risk of loss, death benefit are still better than other options. Yes, including 401k.
I recommend that anyone thinking about IUL google it first, and then if still interested consult a known/trusted financial adviser second. The rules of IUL’s are stacked against the buyer actually getting the kinds of returns that are seemingly promised.