A very popular product in this volatile market are fixed deferred annuities. These are insurance contracts that pay a guaranteed interest rate on the money deposited and grows on a tax deferred basis. Most companies have different break points and surrender periods. For example, the longer you keep your money with the life insurance company in the annuity, the higher interest rate you will receive. They also have bands that pay at higher rates depending on the deposit amount. For example, a higher interest rate might be credited to any deposit above $100,000. The different surrender periods are the periods where there is a penalty to move your money from that company to another. The surrender charge and period will decrease the longer the contract is in force and will eventually go down to 0%. It is just important to understand how many years before the annuity gets to 0%.

We always look at products for our client that have suitable time horizons for their money. For example, if the client is going to need the money in five years, then they shouldn’t buy an annuity with a ten year surrender period. On the other hand, if the client won’t need the money in five years and can wait ten, then there can be a higher with that trade off. It is also important to select a company that has a high financial rating. Obviously, it is important to know the company will take good care of your money. Look for an A rating or better with a company if you are looking at annuities. For a free analysis of your situation and what products are available please email vince@paramountlifeinsurance.com.

There are three buckets of money on people’s financial models and they are taxable, tax deferred, and tax-free.  Obviously, the goal would be to have as much money in the tax-free area as possible.   With tax favorable treatment, the government will put limitations on how much you can put int he tax deferred and tax free buckets.  There is no limitation on the taxable bucket as they want to collect as much current tax as possible.

Most people feel that tax deferred is the greatest thing in the world, but it is not all good.  When something is tax-deferred it means that the tax is deferred to be paid later.  Once the 401k or pension plan compounds for many years, there is also a very large tax bill.  In other words, if you have 1 million dollars your net will be about 30 to 40% less after taxes.  In bucket number 3 which is tax-free, you have limitations in regards to how much you can put in.   The two main tax-free items are permanent life insurance and Roth IRA’s.   Both of them are limited in terms of how much money can be put in on a yearly basis.  With life insurance, each policy has a MEC limit that is the maximum that can be put into the policy and remain tax-free.  If you put money above the MEC limit in the policy then you will be taxed on the gains.  A Roth allows you to put only so much money in per year and then if you earn too much you can’t start one.  If you can learn how to use the cash value of the life insurance through withdrawals up to cost basis and through preferred policy loans, you can avoid paying taxes on the gains.

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.