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Small Business Financial Article

Small Business Financial Article
Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites. Recent books include The American Family Survival Bible and Annuity Facts Revealed: What You MUST Know Before You Invest.

Using Insurance for Optimum Tax Diversification of Your Retirement Income

Using Insurance for Optimum Tax Diversification of Your Retirement Income

One of the more common mistakes people make in planning their retirement income is to assume the best way to maximize their income is to defer as much of their taxes on current investments as possible. Depending on your current situation and your situation at retirement, that can actually result in the least favorable tax consequence. It can also result in reduced flexibility in the way you can access your assets, which may force you into a higher tax bracket. Understanding the current and future tax treatment of different investment options now, can help you arrange your assets for optimum returns, flexibility and tax efficiency. Most people can benefit from diversifying the tax treatment of their retirement investments, which can be achieved using a three-bucket strategy.

One bucket might consist of a tax-qualified retirement plan such as an IRA or 401(k) plan that utilizes before tax contributions and tax deferral to maximize accumulation. However, the income would be taxed at ordinary income tax rates. The second bucket could be invested in investments made with after-tax dollars, which can be taxed at a more favorable capital gains rate. For optimum tax diversification of your retirement income, you could consider cash value life insurance for the third bucket. Here’s why.

Cash value life insurance has unique tax properties that, when utilized properly, can produce some uncommon results.

Tax Free Death Benefit: Most people are familiar with the fact that life insurance provides a tax-free death benefit, which is the biggest incentive for buying it if the protection is needed.

Tax Free Cash Value Accumulation: Cash value life insurance has a savings component in which accumulated earnings grow tax-free. This gives cash value life insurance a leg up on most other accumulation vehicles, especially after the policy has been in force for a number of years.

Tax-Free Access to Cash Value: With most cash value life insurance policies, the cash value can be accessed via tax-free loans up to a certain limit. In many cases, the loans do not have to be rapid, except upon the death of the insured when the loan balance is deducted from the death benefit. If the insured chooses to repay the loan while living, he is actually repaying himself at a low rate of interest.

There are several advantages to utilizing tax-free cash value loans as an income source:

  1. As mentioned, the income would be tax-free. If enough cash value has accumulated, the continued growth of the remaining cash value may be enough to support the policy death benefit and the premium payments for as long as the insured is alive. Some policyholders actually overfund their policies for that purpose.
  2. Cash value loans are not includable as income for the calculation of Social Security taxes.
  3. With many cash value policies, the policy charges a low interest rate on the loan, but they continue to credit the account with interest on the borrowed amount. Therefore, the actual net borrowing cost is very low. That allows the remaining cash value balance to continue to compound its growth.
  4. The insured could consider repaying the loans at some point using another asset to maximize the tax-free death benefit for his heirs.
  5. After consuming the income from the cash value through life expectancy, the policy will still pay a tax-free death benefit to the heir.

Although some financial advisors oppose using life insurance as an investment, it is hard to ignore the remarkable tax properties of cash value life insurance and what they can help you accomplish in the context of an overall financial plan. When structured properly, a cash value life insurance policy can provide a lifetime of tax-free income, while preserving your financial legacy for your family.


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