One result of accumulating wealth may be the hope of keeping assets in the family by passing them on to future generations. Life insurance is a popular way for the rich to maximize their after-tax inheritance and have more money to pass on to the heirs.
Life insurance policies can be used as investment vehicles or simply provide additional financial guarantees. Although life insurance is not limited to the wealthy, people with higher net worth may consider buying it for several unique reasons.
- Life insurance is a useful financial tool for business owners or individuals with high net worth and those who may not have accumulated as many assets.
- It is possible to purchase multiple life insurance policies to meet different financial needs, but this may mean submitting multiple supplementary medical examinations during the underwriting period.
- Life insurance policies are not considered part of the inheritance and are not taxed by the federal government, which may appeal to individuals who want to minimize inheritance taxes.
- A life insurance policy can be sold at its cash value, or you can borrow it at its accumulated cash value during your lifetime.
Tax laws are good for life insurance
One of the reasons why rich people consider buying life insurance is related to taxation. The tax law provides tax incentives for life insurance premiums and income, and provides asset protection in the process. Life insurance proceeds are also tax-free to the beneficiaries. This may be attractive to individuals with higher net worth or anyone seeking to minimize inheritance taxes.
According to the regulations of the US Internal Revenue Service (IRS), policyholders with an inheritance of US$11.7 million or less can leave this amount to the beneficiary without paying inheritance tax, as this is a 2021 restriction. The heirs of the policy holder can use the proceeds of the large life insurance policy to pay the tax bills of individuals whose inheritance exceeds the inheritance tax exemption threshold.
Insurance premiums will not be subject to inheritance tax. For example, if someone spends $500,000 to purchase a $2 million life insurance policy, the initial premium will be deducted from the estate and will not be taxed.
Looking at the premium from another perspective, the after-tax value of US$500,000 is US$300,000; therefore, for US$200,000 (US$500,000 premium-US$300,000 inheritance tax), the family will receive a guaranteed life insurance payment of US$2 million. This is a guaranteed return on premium payment.
The death pension is a tax-exempt asset that can be transferred to the beneficiary.
Life insurance can protect business owners
If the entrepreneurs jointly own a business, then life insurance can fund the sale and purchase agreement in the event of the sudden death of the owner. Family businesses can also benefit from key figures insurance policies. This is insurance for key personnel of small businesses (usually owners, founders or key employees).
The key personnel policy can protect the company from bankruptcy if the key personnel dies before the replacement is in place. As a beneficiary, the company itself can use the proceeds to recruit and train replacement employees, repay outstanding corporate debts, or keep up with daily operating expenses.
To insure key people in the business, you need their explicit written consent as a condition of policy underwriting.
Life insurance as an asset
Life insurance is more than just death compensation. Depending on the type of insurance, it may have cash value or intrinsic value. The accumulation of cash value is a feature of certain types of permanent life insurance, which provides lifetime insurance. Therefore, when insurance is no longer needed, it can be sold as life insurance.
If the structure is reasonable, whole life insurance can provide stable tax-free dividends. This means that your insurance policy can provide an additional source of income when necessary. The cash value in the policy will also increase, which can be borrowed to pay for college or other expenses throughout your life.
Finally, through whole life insurance, your death compensation can be guaranteed regardless of your future health status. This is very important to provide long-term protection for the family and heirs of the policy holder. Each of these benefits may be attractive to individuals with high net worth or anyone seeking to use life insurance as an investment tool.
If you did not have a life insurance policy outstanding loan at the time of your death, the loan amount will be deducted from the death benefit paid to your beneficiary.
Life insurance strategy
There are a variety of insurance plans to choose from. The right choice may depend on your current income needs, your tax situation, and other assets you use to fund your financial goals. Below are three example scenarios of how life insurance can be used as part of a broader wealth management plan.
Retirement plan fund life insurance strategy
Retirement plan funds—individual retirement accounts (IRA) and 401(k)—can be taxed twice for wealthier individuals: first as income and then as inheritance tax. Suppose James has $900,000 in his IRA. To avoid losing most of his IRA to Uncle Sam after his death, James used his $900,000 to purchase a second death insurance policy. After James died, his wife received a tax-free benefit of $3 million.
Use cash surrender value policy to transfer existing life insurance to increase death benefit
Kevin has a 10-year second death insurance policy worth US$850,000 with a death benefit of US$1.53 million. His consultant suggested that he make a tax-free insurance policy exchange. The new policy adds a death benefit of 3.48 million U.S. dollars, and there are no out-of-pocket expenses.
Two-step annuity strategy
Sarah bought an instant joint life annuity for US$1 million. As long as Sarah and her husband are still alive, they will pay US$43,843 each year. Next, Sarah used an annual expenditure of $43,843 to fund a second death policy of $5.68 million. In essence, Sarah converted $600,000 (the original after-tax value of $1 million) into $5.68 million. Finally, both annuities and death compensation are guaranteed.
Is life insurance only suitable for the rich?
Although the wealthy may be motivated by potential tax savings or opportunities to use life insurance as an investment, practically everyone can benefit from it. For example, if you meet the following conditions, regardless of your net worth, you may need life insurance:
- Are married and/or have one or more children
- Is the main source of income for your family
- Dependents with special needs
- Owing to co-signed debts, including student loans, car loans, or mortgages
- Want to leave money to pay for funeral expenses
If you are interested in establishing a financial security measure for anyone you are leaving, then these are all reasons to consider purchasing life insurance. The good news is that life insurance may be cheaper and easier to purchase than you think.
For example, there are many companies that provide affordable term life insurance online based on age and overall health. Although permanent life insurance provides you with lifetime protection, it can be more expensive. Also, if you are not interested in accumulating cash value, you may not need permanent life insurance.
Regardless of net assets or wealth accumulation, life insurance can provide many benefits. When weighing life insurance options, consider what your main reason for buying insurance is, how much insurance you expect to need, and whether you prefer term life insurance or permanent life insurance. Researching the best life insurance companies and obtaining insurance quotes online can help you choose the right insurance policy to meet your needs and financial situation.