How can you take advantage of the advantages of dividend paying whole life insurance? Are you aware of the tremendous advantages that are available to you?
The bottom line is that most of the media and most of the people in the life insurance business have very little understanding or clue about how to use this product. The whole concept is to uniquely fund and structure a dividend paying whole life insurance contract. This concept was really developed by Nelson Nash and I highly recommend you read his book, “Becoming Your Own Banker”.
Once you have funded the policy and creating a liquid fund that you can borrow from, you start to loan yourself money to finance your big ticket purchases. Each whole life contract has a maximum amount of money that you can put in it before it loses its tax advantage. When I say tax advantage, I am referring to the cash value growing tax deferred and the ability to axcess the money on a tax-free basis if done correctly. Each contract has a MEC (Modified endowment contract) ceiling which is the maximum amount before the tax advantage goes away. If you go over the MEC level than the internal buildup of the policy is taxed the same as an annuity. This system allows you to recapture much of the interest that you would typically pay out to a finance company and make their bank grow. This way you can buy a new car and finance it yourself. For example, pull out 40,000 to buy that new car and then pay yourself back at an interest rate above the insurance companies interest rate. When you amortize these payments, like a bank would, you pay yourself back over a period of time. Let’s just say you loan yourself 40,ooo and amortize the loan over 4 years. The insurance company charges about 6 percent for the loan and you pay yourself back at 10 percent. The spread that goes back into your policy is similar to the spread that the bank would typically make. At the end of the 4 year period you own the vehicle outright, your bank has been paid back the full 40,000, and it will have grown with the 4 percent spread it has been making from each payment.
This concept tends to be a major paradigm shift for people, but it works if done properly. The key is that you set it up properly and try and raise the MEC ceiling as high as possible and then capitalize it so you have ample funds available to use. On top of being able to use these funds for loans to your self, it will create a great tax free retirement fund. The living benefits of this system is tremendous and it will also give you a great permanent life insurance benefit that will grow large over time.
Permanent life insurance can be a great supplemental retirement tool to tap into. If you set up the policy the correct way and take advantage of the tax-free benefits, you can see real value.
Many people don’t understand permanent life insurance and that includes many of the agents, CPA’s, Attorney’s, talk show hosts (you know who you are) etc. If you understand how the tool works, I think you will really see the value. The way to set up the life insurance policy to use it as a supplemental retirement, starts with the funding. You should try and fund the policy, just under the MEC level. MEC stands for Modified Endowment Contract and that is when the cash value loses its tax free status. In other words, when you hit the MEC level you have gone to far. The idea is to put as much money in the policy as possible and get the tax advantages available under IRS guidelines.
In order to take advantage of the benefits of a life policy as a tax free supplemental retirement tool, you must know how to access the money. You should start by taking out the money as withdrawals up to your cost basis. Since it is your contributions to the policy, there is no tax up to the cost basis. When you reach the cost basis, then you shift to taking preferred policy loans. If you do it this way, you can avoid paying income taxes on the money. Whatever money you take out as a withdrawal or as a loan, is simply deducted from the face amount (death benefit) of the policy. The only difference is you can’t put the withdrawal money back into the policy if you want, but you can on a loan.
When setting up a permanent life insurance product as a supplemental retirement strategy, it is important to know how to use the cash value. The cash value grows tax deferred and will not be taxed as long as the policy is in force. If you were to cancel your policy and take the cash value out, you would have to pay taxes on the gain above the cost basis.
When you want to use life insurance as a supplemental retirement vehicle, you want to make sure your overfund it. When I say overfund it, I mean to put money in above the premium amount. There is a ceiling that has been put in by the IRS called the MEC limit. The MEC stands for modified endowment contract and once it goes over the MEC level it no longer has the tax free treatment. The government has put a limit on the amount you can shove into a policy because of the favorable tax treatment of life insurance. Make sure to fund your policy under the MEC limit to keep the favorable tax treatment.
Once you get to a point where you want to start taking distributions from your policy, you want to start to withdraw the money from the cash value up to your cost basis. Since it is money you contributed, there is no tax on that money. Once you hit the cost basis, you should start taking policy loans as income and no tax is owed on this either. It is to be noted, that whatever money is taken out of the policy, is subtracted from the death benefit. A withdrawal can’t be paid back, but the loan can be re-paid. It is very beneficial to re-pay the loan as you are paying yourself back and a small interest charge from the insurance company.
When clients think about life insurance and think of it as straight cost, I certainly understand. We are always bombarded with different types of insurance that we need to buy in our life and people feel “insurance poor”. Clients are insuring their car, house, health, and even their blackberry’s now too. If you don’t use those insurances you never see any benefit.
The truth is with whole life or universal life, is that it is beneficial to put as much money as you possibly can in them. The IRS has put a ceiling on how much money you can put in a policy on an annual basis called the MEC level. MEC stands for modified endowment contract and once a policy becomes a MEC it is taxed differently. A MEC makes all of the growth in the policy be taxable. If the client keeps the contract within the limits then the cash value will grow tax deferred. The IRS put a limit on it for a reason.
Most clients struggle with the idea of paying more than the minimum amount. While the minimum amount will generally suffice in keeping the policy going, it could be so much better. How many financial tools do you have in your portfolio that increase in value everytime you put money in? Not many right? In fact, the more money you put in the better it will be.
This can serve as a large paradigm shift for a lot of folks. If you can see more than cost, you may be able to see the beautiful possibilities.
The tax treatment of life insurance is important to understand as you plan for your future.
The death benefit of a life insurance policy is income tax-free to the beneficiaries, but can be subject to estate taxes if the insured estate is large enough. In 2009, the exemption is 3.5 million dollars that you can pass to heirs with no estate taxes. If you have an estate that has a value above the exemption level, you can be subject to paying the estate tax on the amount above. While the exemption stands at 3.5 million in 2009, it goes away for 1 year in 2010 and returns at the 1 million dollar level in 2011. The tax rate in 2009 can be up to 45% and in 2011 it can be up to 55%. The way they have set it up is pretty strange and how it is set up could completely change in the near future. One of the ways people avoid paying the estate tax on their life insurance is to keep it outside of the estate in an ILIT (irrevocable life insurance trust). When that money comes in to the family, they can use it to pay the immediate estate tax bill. Life insurance death benefits are sometimes taxable in some business scenarios, but not usually with individuals.
The cash value of life insurance grows tax-deferred and can be accessed tax free if used correctly. There is a limit on how much money can be stuffed inside a permanent life insurance because of its tax preferred status. If the amount deposited exceeds the policy limit than the policy becomes a MEC (modified endowment contract). Under IRS guidelines, the policy then becomes income taxable. If the policy is surrendered and the policy is cashed out, then the growth in the cash value would be subject to taxation. The correct way to access the money is through withdrawals up to the cost basis and then preferred policy loans.
The premiums are typically are not deductible, except in some business applications.