Any life insurance product, from term to universal life to whole life, shares a primary advantage; their death benefit is received by the beneficiary tax free, unless the policy owner breaks one of the cardinal rules like trying to deduct the premium for income tax purposes.
For permanent policies, like universal life and whole life, the policy’s cash value grows tax-deferred, and distributions can be taken income tax-free. There are no age restrictions to policy distributions, and they can be used for multiple purposes such as college tuition, home repairs or retirement income. This living benefit is widely unrecognized.
“Many people don’t understand the tax advantages of life insurance,” says Craig Berson, President and CEO of Berson-Sokol Agency Inc. “It’s much more affordable than most think, whether it’s term or permanent. The cost ratio of the premium to the death benefit is often more favorable than assumed. That’s why it’s important to talk with a qualified adviser to understand the opportunities a policy can offer.”
Smart Business spoke with Berson about the tax advantages of life insurance and how to unlock each policy’s potential.
What tax advantages do these policies offer?
If a life insurance policy is funded with after-tax dollars, the death benefit is going to be received income tax-free by the beneficiary. This applies to both term and permanent policies. With permanent policies, the cash value accumulates tax-deferred, and distributions can be received income tax-free. Those with a permanent insurance policy can also maximize the tax advantages by paying more premium than is required to maintain the death benefit, allowing the cash value to grow more significantly. In this way, a policy can perform similarly to a Roth IRA, without the contribution ceiling. However, there are some premium limitations, so it is important to discuss the strategy with a knowledgeable adviser before attempting to implement this design.
What other benefits can policy holders unlock?
Many of the newer generation life insurance policies offer provisions where the policy owner can accelerate the death benefit income tax-free in the event of a chronic or terminal illness. These provisions can be included in the base policy, or they can be added with a chronic illness or long-term care rider, which offers enhanced benefits. The illness must be supported by a physician and must include the insured’s inability to perform two of the six activities of daily living (ADLs). These include bathing/showering, dressing, transferring (moving from a bed to a chair), walking, using the toilet and eating. The portion of the death benefit that is accelerated for care will be deducted from the death benefit payable to the beneficiary at death.
Additionally, life insurance is an excellent way to pay for estate taxes and costs. As a general rule, at the cost of 1 to 3 percent of premium to death benefit, the policy holder is essentially using pennies to create dollars. This is increasingly important now that there appears to be a greater likelihood that more people will be subjected to estate taxes starting in January 2026.
What should be understood before attempting to leverage these benefits?
When looking at term insurance, it’s important to understand the convertibility features. Not all term insurance is created equal, and the lowest premium doesn’t equate to the best policy.
With permanent insurance, it’s prudent to explore the internal cost structure of the policy. Some types of insurance, or even different carriers with the same type of insurance, have much higher internal costs than others. To the extent that those costs are higher, less is going to the policy’s cash value.
Also, anyone who thinks they don’t qualify for a life insurance policy because of health reasons should discuss their situation with their broker. Many conditions are insurable at affordable rates.
Before attempting to deploy these life insurance policy strategies, connect with an insurance professional who has a very good understanding of life insurance, and understands the funding rules and the deductibility, or lack thereof, of premiums. Almost everyone can realize the tax-free benefits of life insurance. However, find an adviser who can determine how best to fit life insurance into an overall financial strategy. ●
INSIGHTS Insurance is brought to you by Berson-Sokol Agency Inc.
