‘Tis the Season for Taxes
March 5th, 2014
With the April 15th deadline for filing your personal income taxes looming, I figured it a good time to review the tax benefits of permanent life insurance. While I am not an advocate of investing solely for tax reasons it’s important to understand how your investing strategy is impacted by taxes. Let’s refresh together the income tax benefits afforded permanent life insurance.
1. Tax deferred growth on all cash value. This means that all increases in cash value, including your dividends, grow in your policy on a tax deferred basis. While tax deferred growth is good, what really counts is what you’ll have to pay when you want to use the money.
2. Tax free utilization of all cash value. Here is a key distinction between permanent life insurance and other types of tax favored accounts such as IRAs and 401ks. While you can get the same tax deferred growth in IRAs and 401ks, you are forced to give up access to your money until dates determined by the IRS, typically until age 59 ½. That means, with a few narrowly defined exceptions, you cannot use your money until that point without facing stiff penalties. If your permanent insurance policy is properly structured, you can utilize all of your money, at any time, for any reason, with no penalty. And, the money can be put back
3. Tax free transfer of death benefit to heirs. Here is another key benefit of permanent insurance. Any money left in the account is transferred via the death benefit to heirs of your choosing and your heirs receive the money 100% income tax free. This is particularly exciting when you think about perpetuating wealth across generations. Each generation can grow capital with no income tax, use the money with no income tax, then pass the remaining wealth on (you guessed it) with no income tax. It’s a sort of perpetual motion machine!
4. No contribution limits. Unlike other tax qualified plans, there are no contribution limits or phase outs. That means anyone, at any income level, can benefit from the system.
5. Privacy from the IRS. Because permanent insurance was around before the IRS itself was created, there is no reporting required to claim these benefits. As long as your policy remains incompliance with the IRS regulations of life insurance, contributions and distributions do not have to be reported. The IRS does not have to know how much is going in or coming out of your account.
As you can see, permanent life insurance provides some of the most powerful tax benefits available, without forcing you to compromise the use and safety of your money. So as you are preparing your taxes this year, take some time to analyze the tax advantaged investments you are making. If you find you are sick of giving up access to your own money, reporting everything to the IRS, and taking the risk of rising taxes in the future, contact us at Paradigm Life to learn more about setting up a plan or taking fuller advantage of the policy you already own.
Exploring Mutual Insurance Dividends
February 26th, 2014
One of the primary features of a mutual life insurance company is that they operate for the benefit of their participating policy owners – not stockholders. As a result, mutual companies are making decisions today with the long-term interest of policy owners in mind. The mutual structure is the foundation of the financial strength of these companies, and is the main reason that they are some of the only companies that have been profitable for over 100 years.
Another key benefit of owning a policy with a mutual company is that the policy owner, you, are eligible to receive dividends based on the profitability of the insurance company. Let’s explore the nature of these dividends.
There are three factors that affect the dividend paid to policy owners:
1. Mortality rates
2. Corporate expenses
3. Investment returns
Because there are multiple streams feeding your dividend, dividends from mutual companies have a strong and stable history. In fact, there are many mutual companies that have paid dividends for well over 100 years now.
Dividends can be distributed in many different ways, depending upon your financial goals and needs. They can be sent to you in the form of a check, or they can be used to help offset your premiums. They can even be rolled back into the policy and purchase additional “Paid Up Addition” insurance, which not only increases the amount of your death benefit but also increases your cash values. This can, actually, be considered as a “life benefit.“
Another important feature is that dividends receive special tax treatment. Dividends paid to participating policy owners are considered a return of premium and are, therefore, not considered income by the IRS. This is true up to the point you have received dividends payments in excess of your contributions or tax basis. Until your reach that point, and dividends you take in cash are not reportable to the IRA and are not taxable.
In summary, purchasing a whole life policy from a mutual life insurance company is a financial strategy that you might want to consider.
Life Insurance Dividends and Ultra Strategy: Part Two
February 20th, 2014
With a stock company, the owners of the company are the shareholders and those shareholders, being entitled to a portion of the company’s profits, may receive a dividend, based on the board’s decision to pay. The shareholders and the customers/policyholders are usually not the same, resulting in the potential for a large conflict of interest. This conflict has been the result of many a DNF in the financial world as corporate management faces questions like: Whom do we serve, shareholders or the customers? As pressure mounts, and it always does in these situations, the decision to pay shareholders what shareholders feel they deserve comes with added pressure and is often hastened. As a result, management naturally starts focusing on the quarterly return and thinking short term. At this point, management can begin to behave like a child who just received his or her allowance money. It starts burning a hole in their pocket. History is ripe with stories of customers and corporate culture being short-changed due to this inherent conflict of interest.
In a participating mutual company, the management works for the policyholders’ benefit. Dividends are paid to the policyholders instead of shareholders so no conflict exists. Management is responsible to “guard the safe” if you will, and they act in a consistently conservative manner, doing exactly what they are expected. Without the pressure of shareholders, they can take a long-term vantage point in the decisions and be calm amidst the storms. By virtue of the way they are set up, it would be completely unethical for management of a mutual company to take unnecessary risk to drive profits. Those of us receiving dividends as policy owners of mutual companies know who has our best interest in mind. We cheer for their successes and obviously want them to be profitable. But we also realize that it would be completely unrealistic to expect them to be conservative with our money and then anticipate high returns, just like it would have been impractical of me to think I could run my first ultra-marathon in eight hours.
Being able to think long term gave me the ability to pace myself during the race, exactly the way I’d planned. Knowing I had liquidity in terms of hydration, backup support and fuel assets, provided me a feeling of calm in the midst of the storm. When I got to the, “What the HECK am I doing?” stage, when things hurt and it was easy to doubt myself, I had an anchor that put everything into perspective. I had put in enough training miles prior to race day and as a result, was able to blow through the doubt and keep moving. I knew I could make it. And… when others around me were hurting, rather than causing doubt or concern, I was able to turn that observation into motivation. Dividend paying whole life insurance is no different. Just because times are bad for everyone else doesn’t mean you can’t get ahead, and a mutual company that provides good purchasing opportunities could give you that chance.
The value gained by my experience running continues to serve me in many different ways today. It is always there to draw on in the event I need the strength, and I often “reinvest” it in new experiences. Similarly, your whole life insurance dividends can also be reinvested when you purchase paid-up additions and add to your cash value. They can be taken as cash if you elect and can pay your premiums, if you decide. Either way, they will always be tax-free because the IRS considered them to be a return of premium and after-tax dollars.
My experiences have taught me that being able to think long term and stay disciplined creates tremendous advantages in both running and in personal finance. Though it isn’t always painless, having a long-term vision locked on the objective, a sound, conservative strategy of economic certainty, and a team aligned to it, is, in my opinion, the only way to run the race.