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Money August 2017

Dollar Sense

Life Insurance Is a Flexible Tool

By Teresa Ambord

If giving to your favorite charity or your church is important to you, life insurance adds flexibility in how you do it.... One note of caution: don’t cash in the policy and donate the proceeds, or you could end up owing taxes on the gain. Instead, consider transferring ownership of the policy to the charity of your choice.

Life insurance may seem like just another bill and … who needs another bill? But depending on the type of policy you have, it can offer flexibility in providing retirement funds or help facilitate your charitable giving.

 

Life Insurance for Your Retirement Funds

“Few people have pensions anymore,” says Brett Sause, CEO of the Atlantic Financial Group LLC. “But if structured the right way, a life insurance policy could be the perfect life preserver in retirement.” How?

A permanent policy generally allows you to take cash withdrawals. “When you need money for retirement, you can withdraw funds without paying income taxes, generally up to the amount of the total premiums you paid into the policy.” And if you withdraw more than that, you can borrow against the cash surrender value. The drawback to that is, if there’s a balance owed when you die, it will reduce the payout your beneficiaries will receive, so keep that in mind as you borrow.

Or you can use supplemental life insurance for retirement planning. Here are some of the advantages of doing this.

  • You avoid extra costs, as these plans have low administrative costs and no government reporting. That leaves you more money for expenses, rather than fees paid to someone to manage your investment.
  • There are no contribution limits. IRAs and other plans cap out on the annual amounts you can contribute, but not so with a structured life insurance policy.
  • Early withdrawal is without penalty. You’re probably aware that taking money out of your retirement plan before age 59-½ brings a 10% penalty, plus you must add the amount taken out to your gross income and pay tax on it.
  • Beneficiaries receive death benefit tax-free. IRAs and 401(k)s, on the other hand, are taxable to the recipients. This is especially good for tax planning, given the fact that it’s hard to predict what tax rates will be like when you pass away. Suppose tax rates are a great deal higher than they are today. That means a much bigger tax bite for your heirs if their inheritance is based on your IRAs or 401(k)s, but with life insurance proceeds, it doesn’t matter.

According to Sause, instead of viewing a life insurance premium as another bill that you don’t need, “it should be viewed as a contribution to your retirement, contribution you make to your IRA or your 401(k).”

But that’s not the only advantage of having a life insurance policy.

 

Charitable Giving

If giving to your favorite charity or your church is important to you, life insurance adds flexibility in how you do it. If you have a life insurance policy that you no longer need — perhaps because the kids are grown and independent or — you might consider donating it to charity. One note of caution: don’t cash in the policy and donate the proceeds, or you could end up owing taxes on the gain. Instead, consider transferring ownership of the policy to the charity of your choice.

What’s in it for you?

  • A current tax deduction. The amount of the deduction is the lesser of the policy’s fair market value or your tax basis, which is the amount of premiums you paid, less any amounts you may have received from the policy. There might also be a limitation based on your adjusted gross income, so talk it over with your financial advisor.
  • You avoid tax on the gain you’d pay if you cash in the policy.
  • No estate taxes will be owed, because the amount of the policy will be removed from your estate (provided you live for at least three years after the transfer).

Before you adopt this strategy of donating your life insurance policy to charity, it’s important to check with your insurer and your financial advisor to make sure the laws in your state won’t foil your plan.

You can also name the charity of your choice as your beneficiary, for all or part of the proceeds. This is simpler and more flexible, but has its drawbacks. That is, you won’t get to enjoy a charitable deduction.

But while you’re alive, you can still tap the cash value of the policy through withdrawals or loans, or change beneficiaries if you so desire. Also, the policy will remain in your taxable estate, but the estate can take a charitable deduction for estate tax purposes.

Before you conclude that life insurance is just another bill you don’t need, take some time to view it in terms of the benefits you can enjoy. The right life insurance policy can allow you to live better in retirement or to finally support that charity or your church in the way you’ve always wanted to. At the risk of sounding repetitive: talk it over with your financial advisor.

 

Teresa Ambord is a former accountant and Enrolled Agent with the IRS. Now she writes full time from her home, mostly for business, and about family when the inspiration strikes.

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