Tax Advantages of Life Insurance Deep Dive – Episode 559

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[00:01] Welcome to the Prosperity Podcast. Prosperity thinkers, in the previous episode, we talked about the underfunding, overfunding, and the foundational elements of a life insurance policy. If you didn’t listen to that, you may want to go back. But again, all of these episodes stand on their own. So right now we’re going to talk about the tax advantages and the personal protections of life insurance. Are you ready to take this on? Always. OK, good. So first, we have to say this. As we’re talking about these pieces, a lot of it’s coming from your book, which is Live Your Life Insurance. To give disclaimer in there, we’re talking through this. Some things are going to be subject. And we’ve got those three letter acronym agencies, the IRS that changes stuff.

[00:53] But we’re dealing with a product that has been around, what, a year or two? Maybe longer? I think a couple hundred years is the time frame. OK, cool. So we’re dealing with something that’s been around for a long time. And we’re dealing with something that people have been using to help navigate their lives, protect their families, and that use as a vehicle that is helping them towards prosperity. So, Kim, as we have we set the stage well enough that we can jump into this? Absolutely. And it’s such an important thing to jump into because life insurance does not get special tax law. Life insurance is taxed the way insurance is taxed, all insurance, because it has a job to do, and that is to replace an asset.

[01:46] OK, so what do you mean by it’s taxed like an insurance just for plain language? Are you saying that we’re taxed at the beginning or we’re taxed at the end or no? We’re we’re kind of taxed in this little special category. What does that look like? So let’s go to basic things that most people familiar with car insurance and home insurance. If you have a car accident and you are paid ten thousand dollars to repair your car, you are not taxed on that ten thousand dollars because you took a nonworking car and ten thousand dollars and traded them. There was no gain. And so that is a law around insurance that we must have to acknowledge. Now, where it does get a little more complex is that life insurance has so

[02:36] many other parts along the way and is used for our whole life. But if we will remember that basic thing, let’s start with death first because that’s final, complete and easy. And then we’ll go to the more nuanced aspect of borrowing against cash fight. So if somebody dies and we’ll just use a million dollar death benefit, they were earning, say, even fifty thousand dollars a year. Their income can now be replaced by that million dollars to pay out fifty thousand a year for twenty years. And so, again, that death benefit is not taxed because we have traded a human being earning an income for the lump sum of the death benefit, which goes to the family tax free. Now, if they take that million dollar death benefit and earn interest with

[03:33] it, like put in a bank account or an interest with it, the interest is going to be taxed, but the death benefit itself is not taxed. Good so far. That is good so far. And I really like how you mention because you use the word if you’re taking it out, meaning if we’re looking at as a road that the money has been on, you’re changing the roads. And so there’s a toll that has to be paid of going on certain roads. That’s how my mind looks at it. OK, fair enough. So let’s get into the premium structure and back up a little bit further. So we’ve got dollars going in in the form of premium or paid Either way, we’re building a living asset. This is whole life insurance cash value that is borrowable against.

[04:24] And we’re going to talk about the taxation of that. And then as stated, we’ve got that death benefit. So three phases. And I think it helps people when we compare it to something that they already know, even though I would not compare whole life insurance and a 401k plan I’m going to, but I’m going to use the Roth 401k or the Roth IRA to make the comparison. OK, so I wouldn’t I wouldn’t call life insurance a Roth IRA. I wouldn’t put life insurance in a Roth IRA. I wouldn’t compare them, except from a taxation standpoint, it makes the learning easier. We all know that when we put money in a Roth IRA, it is an after tax contribution. We have to earn 100 grand, give 20 grand to the government.

[05:09] Now we have 80 grand to live on and we can do ten thousand dollars, let’s say, to our life insurance or to our Roth IRA. Same exact tax law. We all typically know that the money grows without taxes, Roth IRA, life insurance, cash value, same tax law. Money is growing without taxes. And then we know that because it was after tax on the front end, Roth IRA and life insurance not upon death, but while living, can come out without taxes. And I do mean come out, not borrow against. We’ll get to the bar against a minute, typically without taxes at the end. Now, again, there’s some nuances and some complexities that need to get delved into more on a personal situation. But essentially, life insurance acts the same as Roth IRA.

[06:04] In fact, Diane Kennedy, which was Robert Kiyosaki’s first CPA before Tom Willwright, says life insurance is the Roth for the rich because rich people cannot contribute to a Roth. So those three tax phases are very important. Good so far. Good so far. OK, and now we have the last, which is what most people are super interested in, which, again, similar to my statement about all of the life insurance assets are like insurance. Now people want to talk about borrowing against cash value. So now we’re talking about a loan. All loans are the same, whether you get your loan against your cash value from the life insurance company or against your cash value from a separate bank or you just go straight to a bank and get a loan.

[06:58] We are not taxed on that money. If you get a five hundred thousand dollar loan to buy a home, you’re not taxed on the half a million dollars to go purchase the home because that’s how loans are taxed. So, again, there’s no special tax law in the life insurance space. Insurance is tech like insurance. Emma Dogg says goodbye, we’re done listening to this. If you’re watching video, you can see Emma in the back. And loans are taxed like loans. Perfect. So the reason why these details matter is what’s happening in our world today and in the news. So I’m going to inject a couple of pieces before we get into the personalized protections. So most people are familiar with the investor Peter Thiel. He was involved with PayPal, with Elon Musk and a bunch of others.

[07:52] So and I’m I don’t know the intricacies of his finances, but from reading that he used Roth IRA for putting a lot of his shares and early wealth, which means that when he’s at the age, he’s able to withdraw and not be taxed so heavily that happens to other founders. Same pieces that you’re talking about here. So it’s really good that you drew that comparison together. So we nailed that. Let’s talk about a couple of the personalized protections, pieces of the policy. And so I’m going to rattle off four different pieces, take them in whichever order you want. We’ve got paid up additions. We’ve got the guaranteed insurability writer, the accelerated benefits writer and the waiver of premium writer.

[08:47] So that did come up with some good ones. I did. Now, that sounds not quite like a foreign language, but we’ll call it that meeting when you have with your accountant and you walk away and you say, oh, that was awful. It’s getting closer to there. So let’s let’s hear this. Yeah, I love it. All right. Well, we’ll do the fun one first, because that’s the paid up additions writer, three words, paid up additions. And most insurance companies call it that. A few of them have fancy names for it. But this is the extra money that people like to put in on top of their premium that we, of course, recommend that they put in when they can. It is optional. Some companies are a little more flexible in their rules than others.

[09:28] But nevertheless, that’s an optional contribution. And it goes 90 to 95 percent to cash value. And depending on the company and the age of the person, between five and 10 percent to the death benefit. Very, very important that that death benefit rises when a paid up addition writer is contributed to, because the death benefit is what keeps the cash value from being taxed. It’s what keeps insurance law in place. So paid up additions writer is extra money, builds cash value and increases death benefit slightly. Good so far. Perfect. Yep. OK, I’ll just go in your order. Guaranteed insurance ability writer is an interesting one with a lot of companies. It’s very, very small. And I don’t mess with it.

[10:17] But for some people in some circumstances, it’s a good thing to have. And essentially what it means is that in the future on either specific events, like if you have a child or get married or on certain ages, like age 25, age 30, age 35, you have the ability to bump up your death benefit slightly. In other words, your insurability, your ability to get approved for new insurance is guaranteed. And you can bump it up slightly. It costs a little more premium, builds a little more cash value, gets a tiny little bit of death benefit. Valuable if you are concerned that your family would have issues with some type of maybe hereditary disease or something that you might be afraid of somebody getting.

[10:59] Again, it’s small, so we don’t focus on it a lot because human life value is always rising. And as long as you’re healthy and we do tend to have a fairly younger, healthier clientele, you can just go get new insurance approved. Nevertheless, valuable thing. Some people want it, especially if they have odd circumstances that run in their family. So that’s guaranteed insurability rider. OK, perfect. I’m going to hit the pause button on one thing with that, which we didn’t talk about in the previous episode, but is relevant. And it’s this your health matters. So if it’s one of the situations where you’re saying, this is something I really want to do, fill the blank next month, next year, five years.

[11:45] If you procrastinate on this, it may no longer be an option. Now, we’re not saying that you’re forced to or anything of that nature, but it is one of those. If you have an unexpected health concern, it may no longer be an option. And that’s a sad thing. Was that a good pause button on that? It’s a very important pause button because I have a friend that was totally fine, healthy, worked out, ate well and ended up in the hospital with a heart attack. And he will be able to get insurance someday in the future. But for about the next 10 years, he’s completely uninsurable. And that’s sad. He had an opportunity there that is now no longer there. And we’re grateful that he lived, right? Because sometimes that doesn’t happen either.

[12:33] Exactly. Perfect. OK, jump to the next, the accelerated benefit rider. So, yeah, this is a accelerated benefit rider. Sometimes it’s an enhanced accelerated benefit rider. Why do the insurance companies do this? Nevertheless, essentially what they all mean and in most cases, you want to have this rider and it’s at no charge. But what they all mean, you do have to check the box to get it is the ability to utilize death early in the event of a chronic illness situation. So you’re in a nursing home. The doctor says you’re down for the count. You got five years to go, seven years to go, you know, whatever the time frame is. You can pull some of that guaranteed death benefit in early in order to pay for care for a nursing home facility.

[13:30] Really, there’s quite a bit of flexibility with what you can use the money for. Very, very valuable rider. Again, doesn’t cost anything, does have to get approved, but it’s not as thorough of an approval process. And if you’re applying for a new policy, it’s very easy to get that added to. You cannot add it to an existing policy. And these didn’t used to exist. Now, if you don’t have one, there are other ways to utilize your death benefit if you have been diagnosed with a chronic illness. Nevertheless, it’s not as easy when you have the accelerated benefit rider. It’s very easy. Perfect. So there is a close cousin to this. We’re not going to get into too much detail, but the close cousin is disability insurance.

[14:17] We highlight on that because that may be one of those for you as a listener. If you’re saying, wait, close cousin, how does that work? We’ll give you a quick explanation and then you can send an email to hello at Prosperity Thinkers dot com to get more info. But let’s give a snapshot of that. Yes. So that is called a waiver of premium. Or did you mean actual disability income insurance, actual disability income, because you mentioned, hey, right here. Luckily, there are smart advisors that say we can use this, but there may be something additional saying, hey, we want to protect ourselves an extra layer. So I just wanted to throw that in. Yeah. So we’ll cover them both at the same time, because they are relevant and they go together on your life insurance policy.

[15:05] You, especially when you’re younger, can get something called a waiver of premium up to I would not have anybody do it over 60. Waiver premium says if I become disabled, I want the life insurance company to pay my premium. Now, remember, premium builds cash value. So it’s a great situation. Separately from that, there is actual disability, separate disability income insurance. And this says if I become disabled, I want to put food on the table and pay my rent or my mortgage and my car loan, et cetera, et cetera. So disability income insurance is for your bills. Waiver of premium rider on your life insurance policy is to keep your premium going, which you could in essence say is your savings.

[15:54] Because back to the disability income, a lot of people have this at work. Some people have it personally. It’s only going to be 60, 70 percent of your income. You’re not going to be able to keep saving. So the two together are a very solid one to punch, because you could get a lot closer to 100 percent of your income being replaced with disability income, doing maybe 60, 70 percent of it, depending on how big your premiums were, your waiver premium doing the rest. And those two together will protect you in the event of the loss of ability to get up and go to work every day. Yeah. OK, I like that. You know, that is where an advisor that’s a master understands us. What is it called? I’m going to I’m going to sound so ignorant on this.

[16:44] The dance in Texas. What is the old boot scoot? It’s the Texas two step is the two step. Yeah. Yeah, there you go. So, again, noticed how these work together and they might work for some people, they might not work for others. Again, that’s where an advisor comes into play. You listed out those four of the personalized protections really well. Now let’s get back into a couple of pieces, which people always talk about, which is the life insurance loan being deductible or not being deductible, because that’s something that everyone’s thinking about. They’re saying, OK, I can forgo using this for a couple of years. I’m going to be disciplined. I’m all in. But when can I use it? Because that’s always what they ask.

[17:32] Absolutely. So Tom Willwright, CPA, has a great book called The Win-Win Wealth Strategy, and he will tell you in that book that life insurance loans can be deductible against investment income only. Now, the insurance companies will tell you life insurance loans are not deductible. So as in all things, you have to take these two very professional, very appropriate recommendations. You know, this is not tick tock to very professional, appropriate recommendations and step back from them. And I have found the easiest way to do that is to borrow against my cash value from a bank instead of against my cash value from the life insurance company, because the loan is likely the same. We could have a difference in interest rates.

[18:25] One could be fixed. One could be variable. The actual rate themselves could be different. So there’s all of that. Nevertheless, if I have a loan from a bank and I can very clearly prove that that loan was to purchase investments, then that loan is deductible against that investment income. It’s from a bank. The accounting is clear and there’s not muddying of the waters relying on the true statement, which is from the life insurance company, which is life insurance loans cannot be deductible. So when Tom speaks about it, he’s very clearly seeing the correlation that all investment interest is deductible. And when that investment interest comes from a bank, regardless of the collateral, it is deductible

[19:09] against that investment income. Is that clear enough? That is clear. And that is the clarity where most people don’t go below the surface. They’re just fishing on the water. They’re getting the TikTok views, but they’re not actually sharing the things that matter. And that’s what you just said, meaning having the smarts to, again, know where to adjust in your account and then when to work with a bank and then when to look at it. Also, the waters get muddy because there’ll be bad actors that say, hey, run everything through here. Put your gas, your purchase of Costco and gas. No, you’re being very intentional with all of this. So this is perfect. We’re going to do another episode. The other episode is going to be all about being the bank.

[20:04] And that is something that everyone talks about. There’s a different approach, a prosperity approach to take this that is far more successful. We’re going to get to that in the next episode. Again, any questions you may have about the type of policy for you, how many policies, who to do it for or disability or how all of this comes together in this dance, send an email to hello at ProsperityTakers.com Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit ProsperityTakers.com