Tax Free Interest Crediting
The use of the phrase “good investment” with life insurance has long been an oxymoron. Traditional life insurance products have had too few investment options for sophisticated investors such as business owners and high net worth individuals. This phenomenon has occurred in spite of the significant tax-advantages that life insurance enjoys in comparison to other financial products.
Tax Advantages of Life Insurance
Life insurance has enjoyed significant tax advantages. In general, life insurance offers five distinct tax benefits:
- Tax-deferred “inside build-up” of policy cash values under Internal Revenue Code of 1986, as amended (“IRC” or “Code”) Sections 7702 and 817.
- Non-recognition of capital gains, allowing the taxpayer to switch investment options within the policy without triggering taxation, under IRC Sections 7702 and 817.
- Tax-free access to policy cash values through a partial surrender of the cash value or through low-cost policy loans. IRC Section 72 (e).
- Income tax-free death benefits. IRC Section 101(a).
- Estate tax-free death benefits through the use of an irrevocable life insurance trust (“ILIT”). IRC Section 2042.
The legislative intent behind these tax-advantages is rooted in social policy designed to encourage household savings and insurance protection.
Benefits of using Indexed Universal Life Insurance (“IUL”)
During a subsequent down year, an IUL principal and accumulated gains are locked in and carried forward (annual reset) to the next contract anniversary.
If the markets should recover the following year, the IUL account value again participates in those gains without having to recover from the previous year’s correction.
Not only do securities not provide this safety from market declines, but an investor can lose substantial portions of both principal and past earnings during a market downturn often requiring extreme market gains just to get back to even. Because of the absence of a potential drop in the IUL account value due to market losses, IUL qualifies as a fixed product under the licensing regulations with the Department of Insurance Commissioners of all 50 states.
You earn interest on your principal
You earn interest on your interest
You earn interest on the money you would otherwise have paid in taxes
Unless held in a qualified plan, securities gains are annually reportable and taxable, thus denying an investor the benefits of such three-fold compounding. Although qualified plans are a better choice than non-qualified plans, they still have issues not present with an IUL. Plan investment choices are normally limited to mutual funds where your account value is subjected to wild volatility from exposure to market risk.
An IUL grows tax-deferred, cannot lose value in a market downturn and imposes no annual tax reporting as it is increasing in value.
There are even more reasons why knowledgeable investors prefer this remarkable savings vehicle, such as how the account value can be used to:
fund major purchases
any other cash need and continue to grow as if the money had never been used.