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Life Insurance & Tax Diversification
An old adage tells us that death and taxes are certitudes. So how can these be addressed – especially for the long term? Putting in place valuable death benefit protection creates a core financial component when looking to your financial future and so is looking proactively at long term tax consequences.
Do you want to find ways to maintain your retirement savings and pay less in income taxes?
While today’s economic environment continues to offer challenges, there are some important strategies to consider as you build your nest egg.
The Importance of Tax Diversification for a Strategic Retirement
It is important to take income taxation into consideration as you plan for the future. If you’re like many today in the midst of planning for retirement, you probably have several different types of investment accounts.
These accounts tend to fall into three general categories as it pertains to how the values within them will ultimately be taxed.
These categories include taxable, tax-deferred (which includes two sub-categories), or tax favoured accounts.
Typical account types separated in categories
(after-tax dollars with potential income taxes along the way):
• Money Markets
• Mutual Funds
• Real Estate Rentals
(after-tax dollars with tax-free dollars out):
• Muni Bonds (in most cases)
• Roth IRAs
• Mutual Funds
• 529 Plans
• Cash Value Life Insurance (when structured properly)
TAX–D E F E R RED
(after-tax dollars in with taxable dollars on gains out):
• Non-deductible Traditional IRAs
• Non-qualified Annuities
(pre-tax dollars in with fully taxable dollars out):
• Deductible Traditional IRAs
• 401(k) Plans
• Qualified Annuities
• Pension Plans
• Defined Benefit Plans
• Non-qualified Deferred Compensation Plans
As you approach your ultimate retirement date, where do you think income tax rates will be — especially since tax rates are at or near historical lows today?
That answer is hard to determine with certainty — however, it’s important to understand how these account types are taxed.
General summary of some of the tax considerations
|Certificate of Deposit||After-Tax||Taxable||Non-Taxable|
|Muni Bond Fund||After-Tax||Non-Taxable||Non-Taxable|
|IRAs – Regular||Pre-Tax||Tax-Deferred||Taxable|
|Permanent Life Insurance||After-Tax||Tax-Deferred||Non-Taxable|
So what is the impact on the benefits shown in the previous chart when your money is mixed among these different categories of accounts? Well, for one thing, having dollars spread among these various account options can give you some flexibility and choice when determining how much taxation you will incur during your retirement years.
Look at the following hypothetical example that shows what would happen if you take 100% of $100,000 out of a 401(k) account (after age 59½) versus taking 50% of the money out of a 401(k) and 50% out of a tax-favored asset , such as a Whole Life insurance policy.
100% 401(k) Withdrawal
|Taxes Paid (28%)||$28,000|
|Total Net Withdrawal Amount||$72,000|
50% 401(k), 50% Whole Life Cash Value Withdrawal
| Whole Life Policy Cash Values|
| Total Money Kept|
| Money Withdrawn|
| Taxes Paid (28%)|
| Net Withdrawal Amount Per Account|
The Importance of Life Insurance Protection
So, you may now have a better understanding of account taxation. But to protect your family in the event of an untimely death, life insurance can be a core component of a comprehensive financial portfolio — providing both death benefit protection and valuable living benefits, such as access to policy cash values for supplemental retirement income.
One of the most common types of life insurance, and the one that has been around the longest, is Whole Life. Whole Life is a versatile financial instrument used for protecting families and businesses while creating and enhancing portfolio wealth.
Whole Life insurance
1. Allows for lifetime insurance protection through a death benefit
2. Can be viewed as a comprehensive portfolio asset in a financial portfolio
3. Contractually maintains guarantees10
4. Offers a non-guaranteed policy dividend11
5. Can create tax advantages – Life insurance is viewed as beneficial for society.
Therefore, significant tax benefits have been bestowed on it that do not apply to most other financial instruments.
These include: income tax-free death benefits, tax-deferred build-up of cash values inside the policy, and access to policy values on a tax-favoured basis
Additionally, there are other advantages to life insurance versus some traditional tax-deferred retirement options for living benefit purposes:
• Funds can be withdrawn at any time without penalty
• No required minimum distribution (as with certain types of retirement plans)
• Loans can remain outstanding indefinitely
• No IRS limits on the maximum premium (other than MEC issues)