You’re probably aware that it can increase your wealth. However, are you familiar with the excellent tax benefits of whole-life insurance? Whole life insurance reduces your taxes. It also increases your wealth. This starts when you take out the policy and continues until you pass away.
So why isn’t everyone doing this? Largely, because people don’t understand how to use whole life insurance. As the name implies, they think of whole life insurance as an insurance product – something to provide for their family when they’re gone. While any whole life insurance policy can do that, it’s not the primary advantage of having one.
How You Can Use Whole Life Insurance to Grow Your Wealth
Growing your wealth with whole life insurance uses a concept called infinite banking. It’s a process with several steps. First, you overfund the cash value of a whole life insurance policy. Then, you can borrow against it to make investments.
Stocks and bonds can vary greatly in a turbulent market. In contrast, whole life insurance provides fixed-rate growth. This stability applies to the cash value of your policy. Typically the cash value of a whole life insurance policy pays dividends with a return of 3-5% annually. The policy earns annual dividends. These dividends are greater than or equal to the interest rate. This rate is levied on loans backed by the policy. Thus you earn money even while taking out loans to make these investments. So how do you minimize taxes with this strategy?
Tax Benefits of Whole Life Insurance
Taxes hinder wealth growth. However, whole life insurance offers tax benefits. These benefits allow you to defer or eliminate many tax costs. We’ll cover three areas where your whole life insurance policy excels at this.
Your Money Grows Tax-Free
One of the biggest advantages of whole life insurance is that your money grows tax-free. Your money grows slower when taxed on growth. This is why many long-term investment options offer tax-deferred status. To illustrate how much taxes can hamper your investments, let’s look at an example of taxed vs. untaxed growth.
Let’s say you had $100,000 in the cash value of a whole life insurance policy with an annual return of around 5%. If you didn’t contribute anything else to the cash value, the balance would grow to around $432,000 over thirty years. Thanks to compound interest, you more than quadrupled your initial contribution and that’s without using it to make any investments. The policy shielded the growth, making it entirely tax-free inside the life insurance policy. Cash flow banking is another way to protect your wealth when using a whole life insurance policy.
Consider the effect of taxing your contributions annually at 15%, the standard rate for federal income taxes. This applies to products like a high-yield savings account or certificate of deposit. After 30 years, the balance would grow to only $348,000. That’s a difference of $84,000. And this calculation doesn’t even include state income taxes.
The tax-deferred status of whole life insurance is just one of its many advantages. Unlike many other tax-deferred financial products, there are few strings attached in how you can utilize the cash value. You can withdraw money from the policy at any time and for any reason.
However, with infinite banking, you never actually withdraw any funds from the cash value. You want to deposit as much money as possible. This is because annual dividends are based on the total amount in the cash value. Making sure you choose the right company for whole life insurance when using infinite banking is essential so that you ensure you are getting the most out of the policy. If you need money for emergencies or investments, you’ll use the cash value as collateral for a low-interest policy loan. This strategy promotes maximum growth through higher dividends. It also avoids any taxation, as no money is withdrawn from the policy.
Tax Advantage Borrowing
The tax benefits of whole life insurance provide significant advantages for borrowing money. Interest rates on policy loans are lower than those of almost any personal loan. These policy loans can then be funneled into tax-advantaged investments that quickly grow your wealth. Since no money is withdrawn from the cash value, it continues to grow. You invest using the policy loans. This approach starkly contrasts with other long-term investment strategies.
Money Grows While It’s Invested
If you have money in something like an IRA or a savings account, you can make withdrawals when an investment opportunity arises. When money is withdrawn though, the principal available for earning interest is lowered.
For example, if you had a $30,000 savings account earning 4% annually, it would grow $1,200 after one year, $1,248 after two, and $1,297 after three. If you withdrew $15,000 from the account to invest, the savings account would grow only by $600 in the first year, $624 in the second, and $648 in the third. You’re missing out on half your annual growth by withdrawing it from the account. Ideally, that money will be invested somewhere with even higher returns than the original account.
Whole life insurance offers a dual advantage. It grows your money in the account and frees up capital for high-return investments. The cash value of whole life insurance grows even with outstanding policy loans. This is because the money is never withdrawn, only borrowed against it. Knowing what dividends you can expect to see after choosing a whole life insurance policy is also important for growing your wealth as well.
However, whole life insurance policy loans do incur interest, even if it’s at a lower rate than a typical bank loan. Fortunately, if the policy loan is used for investment purposes, that’s tax-advantaged too.
Interest on Policy Loans can be Tax-Deductible
Quite often the dividends paid by your policy will offset the interest rates you pay for a policy loan, but if you use the loan to purchase investment assets, that interest is tax-deductible. This is true whether you’re buying a house to rent out, purchasing an existing business, or building one from the ground up. Any interest paid towards investment assets is tax deductible.
There are limits to these deductions. If you were to use policy loans to pay off personal debts or purchase gifts for a family member, the interest would no longer be tax deductible since you’re not using it for business purposes.
Avoiding Taxes with Depreciable Assets
Going one step further to minimize taxes on investment income is using policy loans to purchase depreciable assets. Any income-generating asset, whether it’s a rental property, business equipment, or a whole business has an expected lifetime which it depreciates against every year.
Residential property is expected to depreciate by around 3.6% every year. If you’ve never owned a rental, this might not make much sense, as property values increase by a similar amount each year in most markets. Depreciation deductions aim to offset the costs of maintaining a property in its original condition. Depreciation on business equipment is a little more straightforward as it usually becomes obsolete or breaks down within a specified time frame, in many cases depreciating 10% every year.
In both cases, income generated through these investments is taxable. Let’s say that a $300,000 rental property brings in $18,000 worth of taxable income each year. However, the property depreciates by $10,500 each year, leaving an income of only $7,500 that’s subject to taxes.
While depreciable assets do wonders for your tax bill, there are strategies for utilizing policy loans that will lower your tax bill even further. This is why we highly encourage those using whole life insurance policies to use cash value to purchase investment assets that further reduce overall taxes.
Leveraging Your Money to Buy Life Insurance
One popular strategy is to use infinite banking to buy more life insurance using the loans from your first policy. This lets you increase your death benefit and the total cash value of the policies, allowing you to take out even larger loans at a later date and pass on more money to your heirs tax-free.
Dividends within the policy grow tax-deferred and remain tax-free if you never withdraw from the cash value, offering a great way to grow your money without raising your tax bill.
Transfer the Policy to Your Heirs Tax-Free
Even in death, we’re not free of taxes, but the tax benefits of whole life insurance can help your heirs minimize them. You just need to have a strategy in place before you pass.
Death Benefits are Tax-Free
The final tax advantage to whole life insurance policies is probably the one you’re most familiar with – the death benefit. You can pass down both the death benefit and accumulated cash value to your heirs tax-advantaged and without involving the IRS. As long as you name a beneficiary, the death benefit from whole, term or universal life insurance usually passes on tax-free.
When you name a beneficiary, the death benefit becomes a private contract between two individuals instead of an asset divided with the estate. It doesn’t go through the probate process and is immediately available to the beneficiary. This financial asset offers a reliable foundation, fostering long-term financial security for future generations.
If you don’t name a beneficiary, the state can tax the death benefit as an estate asset. Nebraska, Iowa, Kentucky, and Pennsylvania all levy an inheritance tax on estates. In Pennsylvania, that tax is anywhere between 4.5% for children of the deceased up to 15% when passed to more distant relatives like cousins. On a $500,000 estate, that’s between $22,500 and $75,000 going to the state instead of your loved ones.
Keeping Your Money Out of Probate
Many Americans believe designating an asset to an heir in a will ensures its issue-free transfer. This isn’t exactly true. Regardless of your designations, assets under your control at the time of your death constitute part of your estate. Anything part of your estate needs to go through the probate process.
Probate is the court-supervised process of transferring your assets to your beneficiaries. It involves attorneys, which can be needlessly expensive, and provides an opportunity for creditors and estranged family members to request a share of your assets. High net-worth individuals sometimes seek to avoid the probate process by funneling their assets into things like living trusts, which remove the court from the process but are expensive to set up.
Whole life insurance avoids the probate process and it costs nothing to name a beneficiary for the policy. The transfer process takes weeks instead of months and your heir can start using the cash value of your policy immediately.
The Estate Tax Applies, but Probably Not to You
The value of most whole life insurance policies passes to their beneficiaries tax-free, but there are some exceptions. Even if they bypass the probate process, your gross estate still includes the policy’s cash value and death benefit. If the value of your estate were to exceed the estate tax threshold, which is $13,610,000 in 2024, the estate would owe taxes on the amount above that.
Fortunately, the federal estate tax doesn’t apply to very many families, affecting less than 0.1% of Americans. Several states collect estate or inheritance taxes though, and their threshold could be much lower (still affecting relatively few families). If it does apply, the numbers are pretty severe. The federal government would tax a $25,000,000 estate over $4.5 million. Several states charge their estate tax and the exemption threshold is much lower.
If your estate could fall into these guidelines, we can help you prepare it properly to pass down the majority of your assets without incurring these estate tax penalties.
Minimize Your Taxes with Wise Money Tools
Wise Money Tools realizes that taxes are one of the biggest barriers to growing your wealth. Whole life insurance is an excellent option for earning interest, borrowing for investments, and passing on your money while minimizing your tax burden. For many, this sounds too good to be true, and the principles behind infinite banking and investing with whole life insurance are foreign to most people.
Wise Money Tools can guide you through the process with our free toolkit that’ll answer many of the questions you might have about infinite banking, investing with whole life insurance, and the tax deductions available to you. If you’d prefer something more personal, contact us for a one-on-one and we can go over any lingering concerns you might have
