Every April, Americans all over the country start sweating. You no longer have to join them. In this episode, Patrick Donohoe dives into the powerful life insurance tax benefits working for you as part of the Perpetual Wealth Strategy. From policy inception to death benefit, Patrick reviews the tax advantages other investments and accounts can’t match.
Key Takeaway Timeline
2:12 – Historical tax stability of permanent life insurance
5:55 – The primary tax benefits of insurance
8:23 – Tax benefits of dividends and policy withdrawals
9:50 – The taxation of a 401(k) vs. a Wealth Maximization Account
11:57 – Tax code benefits for small business owners and executives
14:00 – Death benefit liquidity and tax advantages
15:30 – When life insurance could cause an estate tax
Thanks for tuning into this episode. To most Americans, taxes are a consistent source of stress year-after-year. The typical financial planning world has successfully convinced the American public that the best no-brainer tax strategy is to max out your 401(k). If you have kids to put money into 529 plans, if there’s money left over to contribute to a Roth IRA, that’s pretty much it. It’s almost as if you don’t do these things, there’s something wrong with you. In my experience and through the extensive study I have done on this subject, this tax strategy has not helped Americans and in most cases, has damaged a person’s financial future. It’s not to say the tax strategy isn’t important. I consider tax strategy as a vital component of a successful wealth strategy, which is why our approach here at Paradigm Life consists of old tax-efficient financial products and strategic partnerships with tax professionals so that you can not only achieve the best short-term results. Don’t sacrifice the long-term results, which is in most cases the reason why the 401(k) may not be the best approach. We’re going to dive into a few of the powerful tax benefits of the Wealth Maximization Account, which is a dividend-paying whole life policy designed for maximum cash value. For those of you who are clients, your WMA is the foundational piece of your wealth strategy or a primary piece. Having complete knowledge of its tax benefits is important. It’s also important to note the long-term tax benefits as well. It can help you navigate not right now, but your future path to financial independence. Let’s go ahead and get started.
The permanent life insurance has been around for a long time. It preexisted the United States and 1913 Income Tax Act, the income tax, which was supposed to be temporary but ended up being permanent. Rates have been increasing ever since. I look at it as this foundational piece of a wealth strategy. It’s not just because of the tax benefits, but the tax benefits help. What’s interesting is the policies, dividends, interest, it pre-existed the Income Tax Act. Not to say that it hasn’t been impacted since because it was. In the 1980s, there was some tax overhaul and life insurance was included. It was a last-minute thing, but it hasn’t been impacted since. It’s interesting that it has been on the table with many administrations, notably a couple of times with the Obama administration, but it was also part of the 2017 potential tax reform, which we went through over the last couple of years. It was on the table, but if you look at why it wasn’t included, it’s because number one, it is a huge lobby associated with it. The financial services lobby, the insurance lobby who was able to talk to Congress, representatives and educate them on the nature of insurance and how it replaces loss.
If our car gets hit or demolished and we get a car replacement. We’re not paying taxes on it. It replaces something that already exists. As far as cash value is concerned, being this net present value of a future benefit, it makes sense. Them being able to sensibly get into these lawmakers’ offices because of their clout and influence helps educate on the reasons behind why there are many tax benefits with insurance. Not to say that’s going to continue to happen, the future is unknown. Looking at the past, there are a couple of things that I would say provides me peace of mind and certainty. It should provide the same thing to you. Number one, it’s only been changed once and the changes only affected contracts and policies going forward. It didn’t affect the ones that were already in force, which is interesting to note. If things happen in the future, it’s because it’s a contract. Essentially, the two parties that went into this contract, you being one of them, me being one of them, the insurance company being the other, they did so with an understanding of the environment of taxes. If tax has changed on existing contracts, there are definitely repercussions when it comes to contract law. Looking forward, I think the peace of mind is that things do change. We already have policies that are part of our financial strategy or wealth strategy that they won’t be affected. It’s not a guarantee but you looked up to the past, and it provides a much higher degree of certainty than the other types of financial products that are out there and their taxation. The primary tax benefits struck again into everything. There are lots of different ways to use insurance in estate planning, business strategy and business planning. I want to talk a few of the primary ones that affect everyone. If you have questions about anything that I’m talking about, feel free to reach out to the team. Go to the ParadigmLife.net podcast page. It has contact information. It also has a few supporting documents that are going to help you as well. Reach out to your wealth strategist as well. If you’re not a client, go to the website and there are a few places you can request more information or talk to someone. Let’s get into the primary one. The tax-free growth of cash value, that’s an interesting one to note.
Let me first talk about the typical taxes that are out there. You have taxes on dividends. You have taxes on capital gains, short-term and long-term gains. You have taxes associated with income. If you look at a policy, a policy has a guaranteed interest or guaranteed growth associated with the cash value as well as a dividend that’s paid because it’s a mutual company. There are no taxes on that growth. The money is growing inside of a policy. You’re getting a dividend. We recommend having dividends continue to compound. Setting it up that way, you have tax-free growth. There are some things to note when it comes to the different ways you can withdraw or take money out of a policy. The first one is you can change the way in which a dividend is paid. Usually, we default to compounding within the policy, but you can request it to be paid in cash. You can also take a partial withdrawal or surrender of cash value. The third way, which I would consider the typical way that we teach and advocate is to use a policy loan, which is a loan from the insurance company that is collateralized by the policy. Nothing leaves the policy. Money comes from insurance companies from other accounts, other products and so forth. Those are the three primary ways. Both dividends and withdrawals, there are some things to note here that are important. The withdrawal, the basis amount, which is the amount you contributed over the course of time. That amount is tax-free. For instance, if you had an older policy and you had $500,000 of cash value and you’ve contributed $250,000 of premium or contributions when you start to take to the dividends or partial withdrawals, you can withdraw up to $250,000 without paying any tax. When you go to $250,001, that is when the $1 would be subject to income taxes. That’s how that works. It’s essentially first in, first out. That’s the nature of that taxation. The policy loan is not taxed, which is interesting because we will typically teach, if you are setting your policy up specifically for future income purposes, you can withdraw all of what you’ve put in. Once you get to, in this case, $250,001, switched the withdrawals to a loan because those loans are not subject to taxation. That’s usually the tax benefit associated with the growth of a policy as well as the withdrawal.
When you look at a 401(k) and how the tax benefits work there, you contrast that to a Wealth Maximization Account. In the 401(k), there’s no tax on the contributions. You’re putting money in. All the money that goes in, the subsequent growth, the taxes are deferred. When you take money out in the future, you are taking money out at what the income tax rates will be at that time. That is subject to essentially the contributions as well as the interest and the gain. We have a certainty associated with what tax rates are. We don’t have a surety of what they will be in the future. If you look at the existing state of our country when it comes to it being fiscally challenged, taxes are most likely going to go up in the future. I would say they have to go up. Looking at contributing money to a 401(k) right now when tax rates are seemingly low and withdrawing that money in the future when tax rates are going to be higher, it should be a no brainer. That’s not necessarily a recipe for success. I would say from a worry and anxiety standpoint coming from uncertainty, it’s betting that the government is not going to change the taxes in the future. With the policy, you are contributing the opposite. It’s very similar to how a Roth IRA is taxed. You are contributing to it with after-tax dollars. You pay your taxes, then you contribute. You have a degree of certainty right now that there is likely never to be any tax associated with the policy proceeds ever again. It’s not a guarantee. We have a high degree of certainty there. Let me get into a few other things with relation to business uses of a policy as far as funding is concerned. I’ll talk about the death benefit or what we call the legacy benefit. There are many creative ways to use the Tax Code to benefit small business owners as well as those who may be executives with bigger corporations. Let me about the small business owner first. With the small business owner, there are ways in which you can pay a key employee using a 162 strategy. 162 is a section of the Tax Code that has to do with executive bonus and you could use that in order to have a deduction to the company, and pass on some of those taxes to the employee. There are ways in which you can structure it so it makes sense for the employee. Those proceeds can go into an insurance policy as opposed to a qualified plan.
We have done several of these for our clients. For a corporation, maybe you are an executive with a corporation or you are maybe one of the primary shareholders or an owner of a corporation. When it comes to executive pay, I talked about this in the book I wrote, Heads I Win, Tails You Lose, where you can essentially use a split-dollar arrangement. Therefore, the executive can receive compensation that subsequently pays for a policy premium. There’s very little tax associated with that. It’s a great way to retain top talent and so forth. I’m not going to get into a lot of those details. If you guys have questions, definitely reach out to either your wealth strategist or our team here. Let’s talk about the death benefit, the legacy benefits. These benefits also apply to term life insurance. It’s pretty much the only tax benefit of a term life insurance policy. The proceeds of a policy, when something happens to someone you own the policy on, or maybe you’re the beneficiary of a policy, they will not be taxed from an income tax standpoint on those proceeds. It’s worthy to note that the liquidity of insurance is unprecedented. If you look at estates that I’ve seen transfer from one generation to the next, having to liquidate securities, sell securities at different times depending on where the economy is as well as real estate assets or business assets. It takes a long time. Looking at insurance, it’s getting even better than this, but within a few weeks, you will be able to have a check or there are a few ways in which you can take money when proceeds pay out. You have that money within a couple of weeks. Looking at how your financial situation will change over the course of time, right now maybe for growth purposes. In the future, there may be some purposes to use it as the primary legacy asset. In the book, I talk extensively about a few ways in which you can do this, so check that out. When you do pass away, there’s no income tax associated with those proceeds. Looking at the estate tax, this is where it could potentially trigger an estate tax. Life insurance proceeds, if it’s owned by you, the beneficiary is an irrevocable living family trust, the proceeds are still included in the estate calculation. The estate tax exemption right now is high. It’s the highest in history. It’s been much lower. Right now, it’s almost $12 million per person. There may not be as much worry for you. At the same time, I see this potentially changing in the future. Right now, the government needs as much tax revenue as possible.
Looking at the amount of money that’s going to transfer from the Baby Boomer generation, they’re licking their chops right now. Pay attention to that. There are ways in which you can have your insurance policy put into an irrevocable trust. There are a few different types of irrevocable trusts that are out there. Some are very restrictive. Some are more modern and you have more control over. Contact us and we’ll get through what options may be appropriate for you. Looking at what we specialize, we’ve talked a lot about wealth strategy and the scope of wealth strategy specific to estate planning as well as a tax strategy. We have a strategic network and it’s a strategic network that we’ve developed over the course of time. They consist of tax professionals as well as legal professionals. Looking at what we’re able to do and who we’re able to refer you to, it may be appropriate to further enhance what the policy can do for you. If that’s the case, if you guys have any interest there, definitely contact your representative, your wealth strategist, or go ahead and contact us on our website. The website has quite a bit of information on there. There’s a whole podcast page. There are some deliverables associated with this episode. You’re going to want to bookmark that and check that out. Also, sign up for the email list because it will notify you when there are new episodes up. Thanks for joining me and giving me your continued time and attention. It means a lot. I enjoyed doing these episodes. I believe that your ongoing financial education is important. I’m honored to have you here and have your support. Join me next time as we get into one of the most often misunderstood benefits of the Perpetual Wealth Strategies, specifically the Wealth Maximization Account, which is the loan provision. We’re going to dive deep into the options that you have both now and potentially in the future, which can positively impact your financial life. We’ll see you next time.
About Patrick Donohoe
Patrick is the President and CEO and started Paradigm Life in 2007 after learning from his mentor Kim Butler about financial strategies outside of Wall Street. With a background in economics and marketing, Patrick immediately realized the opportunity to teach investors, business owners, professionals and families on a large scale using modern digital media and communication technology. Since 2007 Paradigm Life has worked with thousands of individuals in all 50 states. Patrick has shared the stage with financial experts such as Robert Kiyosaki, Peter Schiff, G Edward Griffin, Tom Hopkins, Blair Singer, and more. Patrick co-created the Cash Flow Wealth Summit (www.cashflowwealthsummit.com) with his friends Tom Wheelwright, CPA of Provision Wealth and Andy Tanner, the author of 401kaos and Stock market cash flow (have links to their websites and books). Patrick hosts The Wealth Standard Radio – a popular financial podcast every Wednesday morning at 9am MST on the Tune In Radio Network. The Wealth Standard Radio has been on the air since 2007. Patrick grew up in West Hartford, Connecticut and moved to Salt Lake City in 2003 to attend the University of Utah and graduated with a BA in Economics. His yearly highlights are a family trip to his parents home in Cape Cod, Massachusetts and to Hermosillo, Sonora Mexico where his wife Synthia’s family resides. He enjoys playing ice hockey and is an avid participant in CrossFit. Patrick currently resides in Salt Lake City, Utah, with his wife Synthia and their three children Hannah, Meghan and Jack.
A Wealth Maximization Account is the backbone of The Perpetual Wealth Strategy™