In times of financial uncertainty and market volatility, a “permanent” life insurance contract can provide a measure of stability to your estate and financial plans.
Permanent Life Insurance
Permanent insurance is a colloquialism that includes diverse types of policies, such as whole life insurance, variable life insurance, universal life insurance and index life insurance. Each policy type has specific attributes and benefits which can vary widely from policy to policy. In addition to providing a death benefit, often a policy of permanent insurance will build cash value inside the policy. Some or all of a policy’s cash value may be necessary to support its death benefit, especially in the policy’s later years. The policy owner may be able to access this cash value during the insured’s life.
Taxation of Life Insurance
Life insurance is a tax-favored asset. Cash value inside the policy grows without income tax. Also, unless certain exceptions apply, the death benefit is not subject to income tax. If the death benefit is not paid to the insured’s estate, the policy is not owned by the insured and the insured has no incidents of ownership in the policy, the death benefit will also be paid free from federal estate tax.
Steady Your Plans with Life Insurance
Each family’s estate and financial plans are unique. Life insurance can be used in different ways to provide a foundation for meeting a family’s financial goals and objectives. Following are ways that life insurance could fit into your family’s plans.
A base amount
Senior generations can transfer wealth to junior generations. Often senior generation members would like to leave each heir a certain amount when they die. Yet asset values rise and fall with the market, businesses can fail, the cost of illness and long-term care can consume assets, and retirement can last longer and cost more than expected. Nevertheless, when you die, your properly maintained life insurance will pay the death benefit promised in the policy. As a result, no matter the value of your other assets, the death benefit from a life insurance policy can be there to provide your family with a base amount.
Avoid selling into a down market
The U.S. government and many of the individual 50 states impose some form of transfer tax upon death. Often those taxes are due within nine months of your death.
“If you should die when market forces have diminished the value of your assets, the cash death benefit from a life insurance policy can be used to help pay transfer taxes, preventing the need to lock in losses (or reduced values) in other assets by selling them to pay such tax.”
It is important to consult an experienced attorney to structure this type of planning to prevent the death benefit, itself, from being subject to a transfer tax.
IRD is not worth what you think it is
Certain assets, known as income in respect of a decedent (IRD), remain subject to income tax following the death of a taxpayer. IRD includes qualified retirement plans and individual retirement accounts (IRAs), other than Roth accounts and Roth IRAs, and other income earned before death but paid thereafter. If your estate is large enough, your IRD is subject to both an estate tax and an income tax (although there is an income tax deduction for estate tax paid). Because both income and transfer taxes may be imposed on IRD, it is worth less to your beneficiaries than its face value. A life insurance death benefit can replace this wealth lost to taxes.
Investing without income tax
Certain life insurance policies permit their cash value to be invested in funds similar to mutual funds. The income earned by the funds is not subject to federal income tax. Depending on the policy’s terms, income earned by the policy could increase the death benefit over the face amount. In fact, some policies allow the cash value in the policy to be added to the death benefit amount. As described above, subject to certain exceptions, the death benefit from a life insurance policy is not subject to income tax. Accordingly, it may be possible for your family to receive a policy death benefit, including the value of the policy’s investments, without income tax.
A reserve of value
The terms of some policies allow the owner to access the policy’s cash value before death. This can be done by withdrawals of cash or borrowing from the policy. Withdrawals come first from basis (investment in the contract); after basis is exhausted, amounts withdrawn are subject to ordinary income tax. Borrowing cash value does not, itself, generate income subject to tax (and neither will the repayment of a loan from the death benefit after death). However, the surrender or lapse of a policy could result in ordinary income to the extent cash value borrowed and/or received in surrender exceeds basis. Even still, if needed, cash buildup in a life insurance policy can be a reserve against need.
When considering whether to access the cash value in your policy, caution and analysis is necessary.
“Before considering a policy distribution or policy loan, discuss its impact with your tax and insurance advisors. Remember, policy loans require interest to be paid to the insurance company.”
The return on the policy’s cash value (investments) may cover the interest cost, but if it does not you may have to pay the excess interest from other assets (or income). Also, depleting cash value or taking large loans could cause (or hasten) a policy to lapse or eliminate policy guarantees.
Asset and investment protection
Depending on state law, some (or all) of the cash value of and some (or all) of the death benefit from a life insurance policy may be exempt from the claims of the insured’s creditors. Also, policies can protect you from market declines by investing in ways that limit investment losses (but those policies may also limit investment gains).
Wealth preservation if the worst happens
If you need care at the end of your life or following an illness or injury, you could deplete your assets paying for it. Long-term care insurance may be expensive to obtain (even when young and healthy), and many object to paying premiums for insurance that may never be used. Yet, there is another way to protect your wealth from the cost of providing for long-term care.
“Many life insurance companies can add a long-term care rider to a life insurance policy. Depending upon the terms of the contract, during your life, should you need care, you may be able to access the policy’s death benefit to pay for it.”
Of course, if you use the death benefit to pay for care, it will be reduced (even to zero) when you die. Nevertheless, such a policy of life insurance could provide for your care and preserve your other assets for your family.
Part of Your Plans
Life insurance is an important part of any wealth transfer plan. No matter your stage in life or level of wealth, life insurance can provide a tax-preferred way to accumulate wealth and then pass it on after you are gone. Your PNC Private Bank® team can introduce you to an insurance strategist who works with your wealth strategist to discuss how life insurance can be included in your estate anad financial plans. To learn more, contact any member of your PNC team.
