Exploring strategies for leveraging life insurance as a savvy tax-efficient investment, we’ve gathered insights from six industry experts, including presidents and CEOs. They discuss tactics ranging from utilizing split-dollar arrangements to designing for tax-free legacy planning, offering a comprehensive look at structuring life insurance for tax benefits.
- Utilize Split-Dollar Arrangements
- Overfund for Tax-Deferred Growth
- Align RMDs with Standard Deduction
- Maximize Non-MEC Contributions
- Establish an Irrevocable Life Insurance Trust
- Design for Tax-Free Legacy Planning
Utilize Split-Dollar Arrangements
One strategy I really recommend for using life insurance as a tax-efficient investment vehicle is what’s known as the “split-dollar arrangement.” You’ll see this built into executive compensation all the time, but individuals can use it too, if they’re looking for a little tax break. Basically, the way it works is that the funding of life insurance policies can be split between two parties, maybe an employer and an employee, or a family planning an estate, and the premiums, the cash values, even the death benefits—all of that can be split according to whatever terms were agreed to, and that can be set up to maximize the tax benefit for everyone who’s involved.
In this arrangement, the investor can see some real tax savings on premium payments since these costs are often shared or covered by loans from the policyholder. This can be arranged as employer contributions in a workplace setting or as gifts that fall under the annual gift tax exclusion in more personal financial setups. This isn’t just good for tax planning; it also boosts the potential for better investment returns on the cash value of the policy, which grows without getting nibbled away by taxes.
Plus, the death benefit, when it eventually pays out, is tax-free to the beneficiaries, making this a really strong option for accumulating wealth and planning for your legacy. While it’s a bit complex, navigating the ins and outs of split-dollar arrangements can offer some substantial advantages for those who can work through the regulatory and agreement details.
Eric Croak, CFP
President, Croak Capital
Overfund for Tax-Deferred Growth
One effective strategy for using life insurance as a tax-efficient investment vehicle is to leverage a permanent life insurance policy with a cash-value component. By overfunding the policy within IRS limits, you can accumulate tax-deferred growth. Additionally, you can access the cash value through tax-free policy loans, providing a flexible source of income in retirement. This approach offers both death benefit protection and potential tax advantages, making it a powerful financial planning tool.
Amber Benka
Insurance Agent, California Business Insurance
Align RMDs with Standard Deduction
When it comes to efficient tax planning, several aspects need to be considered. The first step is to review their 401(k) accounts and projected balances. Once they reach the required age, they will need to take Required Minimum Distributions (RMDs) from their 401(k) accounts. This income will be factored into their provisional income and combined with their Social Security benefits and any potential pension plans.
The goal here is to plan for the RMDs to align with their standard deduction, so they can be income-tax-free and not affect their Social Security benefits. This leads to the question: What is the optimal balance in their taxable retirement accounts when RMDs begin? According to David McKnight, this balance is around $400,000 (though this number may change due to inflation adjustments and tax code updates).
In other words, if a client’s balance exceeds $400,000, their RMDs will push them above the standard deduction, resulting in higher taxes.
This is where properly structured life insurance comes in. Life insurance can be designed to maximize the cash value account. As mentioned earlier, withdrawals from life insurance are viewed favorably by the IRS and can be income-tax-free.
There are calculators available to help project the balance of retirement accounts at the time of retirement. From these projections, we can “back-engineer” the strategy to determine if contributions to taxable accounts should be reduced and funds allocated to a life insurance policy instead.
This approach allows a client to use funds from Social Security, tax-deferred accounts, life insurance, and possibly Roth accounts (401(k) and IRA) to fund their retirement. If they need additional funds—perhaps for a vacation or home repairs—they can withdraw from their life insurance without increasing their taxable income beyond the standard deduction.
To summarize, life insurance serves as a supplement to an existing retirement plan. The goal is to diversify and allocate funds that would otherwise increase the balance of taxable accounts beyond the “sweet spot.”
Zhaneta Gechev
Agency Owner, One Stop Life Insurance
Maximize Non-MEC Contributions
I’ve seen that utilizing a permanent life insurance policy, such as whole life or universal life, can be an effective strategy for tax-efficient investing. One key benefit is the policy’s cash-value component, which grows tax-deferred over time. This allows the investment to compound without being eroded by taxes, which can be particularly advantageous for long-term wealth accumulation.
A strategy I recommend is to structure the policy so that you maximize contributions up to the IRS limits without turning it into a Modified Endowment Contract (MEC). By doing this, you can ensure that your cash value grows tax-deferred and that you can later access these funds through tax-free policy loans or withdrawals, as long as they don’t exceed the premiums paid. This can be a smart way to supplement retirement income without triggering taxes.
For those considering this approach, it’s essential to work with a knowledgeable advisor who can help structure the policy correctly and align it with your overall financial plan.
Kenan Acikelli
CEO, Workhy
Establish an Irrevocable Life Insurance Trust
Life insurance offers important tax advantages that can benefit both families and business owners when included as part of an estate plan. Currently, the federal estate tax rate is 40%, and 17 states also impose taxes on estates or inheritances at the time of death. By setting up a life insurance policy within an Irrevocable Life Insurance Trust (ILIT), individuals can mitigate estate or inheritance taxes for a fraction of the cost, as the tax-free policy is not considered part of the deceased person’s estate.
As the current estate tax exemption stands at $13,610,000 and is set to expire at the end of 2025 (unless statutorily amended), strategic estate planning will become a significant concern for a larger number of American families if the exemption is significantly reduced to pre-Tax Cuts and Jobs Act levels.
Eric Gross
Certified Financial Planner (Tm), Grodin Financial & Insurance Services
Design for Tax-Free Legacy Planning
Without a doubt, the flexibility attributed to life insurance design makes it one of the more desirable planning tools when it comes to blending both tax and distribution timeline considerations. We find that clients who wish to leave a long-term tax-free legacy (and might have been able to accomplish this before recent legislative changes using a Roth IRA) are now turning to a well-designed, life insurance-based plan in order to provide both a lifetime payout as well as a tax-favored payout for their heirs. There is little else available today that can accomplish both of these goals.
Bryan Rex
Financial Planner, Cornerstone Financial Services Inc.
