Term vs. Whole Life Insurance
In recent years, whole life insurance has been criticized as a poor investment, offering low returns and high premiums. Many financial advisors and specialists have recommended term life insurance, which has lower premiums.
Some have suggested that individuals not buy life insurance at all, but instead invest the money they would have paid in premiums in other financial instruments, such as stocks and bonds. However, whole life insurance does have financial advantages, including deferred income tax on returns and ways for beneficiaries to avoid estate taxes altogether.
Whole Life Insurance vs. Term Life Insurance
Term life insurance is temporary insurance with no cash value. When it expires, it has to be replaced or renewed, so the insured has to repeat the application process and usually pay higher premiums for the renewed policy. Whole life insurance is a type of permanent life insurance that never expires and builds cash value, which pays a stable rate of return, usually more than the interest on savings accounts. It remains in effect as long as premiums are paid, up until the policy reaches its predetermined term period, or the insured cancels the policy or dies.
Whole Life Insurance vs. Investments
This sounds like a great option, but the truth is that most people don’t set aside the money for investments or savings. They spend it and have no life insurance and no extra money in investments. Whole life insurance is a way of making sure the money is invested and saved while providing protection for dependents.
There is virtually no risk in whole life insurance, so the money won’t be lost as it may be if invested in higher risk investments like stocks. Returns on life insurance are tax-deferred, while returns on other investments (stocks and bonds) may be taxed as income tax or capital gains when earned.
Other Advantages of Whole Life Insurance
Successful investing takes research, constant updating and time, while whole insurance requires a check or online payment once a month. Investment income is taxed at the time the returns are received, while dividends and interest on the cash value in life insurance are tax deferred until the cash is removed from the life insurance policy.
If a personal or business loan is taken on the cash value of a whole life policy, the income tax is still deferred, even if the loan isn’t repaid.
Whole Life Insurance As An Investment
While investment gurus criticize whole life insurance because it is not as liquid (available) as other investment income, this is actually an advantage for some people. In successful investing, returns are reinvested, but many average investors will spend the extra money instead of building on their investments.
Whole life insurance as an investment is a no-risk investment that requires minimal work and cannot be as easily accessed as a savings or investment account, so policyholders are less likely to withdraw their investment.
Death Benefits and Taxes
Beneficiaries need to be concerned about three types of taxes: income tax, estate tax and capital gains tax. Cash and financial instruments are subject to both income tax and estate tax, and inherited property which is sold is subject to estate tax and capital gains tax.
The death benefit on a whole life policy is not subject to income tax or capital gains tax, and there are ways to shelter it from estate tax. A death benefit is also more liquid than other investments that become part of an estate. Learn more about life insurance taxes.
Whole Life Survivorship Policies
For people with large estates, whole life survivorship policies (second to die) may offer tax benefits to heirs. These policies are usually purchased by married couples and do not pay a death benefit until the second person dies. With proper planning, no estate taxes are paid when the first person dies, and there are ways to shelter second to die death benefits from estate taxes. Since tax laws on these policies are vague, it is best to consult an estate attorney before purchasing a survivorship policy.
Irrevocable Life Insurance Trusts
Another way to shelter fairly large amounts of cash in an estate is to cede ownership of a whole life insurance policy to an irrevocable life insurance trust. The policy remains in effect and the death benefit is paid to beneficiaries, but since the insured no longer owns the policy, it is not considered part of his estate.
Heirs are sheltered from estate taxes, but the trust may be subject to income tax or gift tax if it is not properly structured, so it is important to consult an attorney.
Buy Whole Life Insurance – Get In Early
There are many advantages to whole life insurance, from both an investment and a tax perspective. Getting the most from whole life insurance means buying a life insurance policy while you are still young, rates are lowest, and payments remain fixed over the life of the policy.
If buying a whole life insurance policy as a tax shelter for an estate, look at single payment policies, which offer the best value for older people. Consult an estate attorney about setting up an irrevocable whole life insurance trust as a shelter from estate taxes.
Whole Life Insurance Quotes
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