Is this the end of tax advantages for life insurance?
Current tax benefits for life insurance
For more than a century life insurance has enjoyed significant tax advantages aimed at both owners and beneficiaries of policies. Cash value life insurance policy accumulation values are not taxed if the money stays inside the policy. These plans act much like a Roth IRA–after-tax dollars go in, no tax while accumulating, and tax-free death benefits when the policy pays at death. While you’re alive, you can borrow on the policy or withdraw your “basis” in the policy tax-free. Once you take out more than you’ve put in, the difference is taxed at ordinary interest rates. This tax deferral is a HUGE benefit of owning these types of policies. I know, I know, “but this is a term insurance web site”… Reality is that many people do buy these policies and hold them for long periods. They pay off, too. Most life insurance claims are from permanent insurance policies.
What President Trump Will Change
Under President-Elect Trump’s proposed tax plan, the tax-deferred/tax-free cash accumulation would be eliminated. According to Trump’s plan he would “Repeal the exclusion for investment income on life insurance contracts entered into after 2016”.(Brookings Institution analysis) This takes a major incentive to own permanent life insurance, and there are some big reasons why folks would purchase these policies for business and estate tax funding among others. Tax-free buildup, as it’s known in the insurance world, is a cornerstone benefit to policyholders. The major life insurance lobby in the US, the National Association of Insurance and Financial Advisors (NAIFA) and others have fought Congress for decades over this issue and have won major victories on behalf of policyholders and agents alike.
What Does This Taxation of Cash Value Buildup Mean For Me?
Simply put, if you’re buying nothing but term life insurance, probably not much. Nothing changes with the death proceeds of a life insurance policy- that’s great. Also, this taxation of cash value won’t take place on contracts entered into before 2017, so their grand-fathered. So, really, the only folks who would realistically be affected by this are the people who want to purchase permanent cash value life insurance when they’re young. Even then, I’m not so sure that this is a bad thing altogether. Most young people today should really be starting out with term insurance anyway. You get the highest return on your life insurance dollar with term policies and you’re not paying high commissions to an agent unnecessarily, not to mention huge surrender charges where you won’t break even for possibly decades if ever when you cash out.
The Insurance Industry Will Adapt
Our industry will adapt-it always has and always will, like any other business. When interest rates were well over double digits and people were cashing out their old whole life policies and investing the proceeds in money markets, the insurance carriers invented an alternative called Universal Life, which was, essentially, a term life policy coupled with an internal money market account wrapped by a life insurance contract. Interest rates those policies credited were equivalent to outside money market rates and were a viable alternative. Earlier this century, after the new actuarial table- the 2001 CSO Table was introduced, major insurance companies came out with modern universal Life policies which offered low premiums and almost no cash value so as to enable the policies to keep a level premium for the life of the policyowner. This was in response to the CSO table’s reflection of greatly improved life expectancy. If people live longer, then they can pay longer before the policy pays off, so they can charge less. I predict the same thing will happen if Trump’s tax plan goes into full effect, where long-term policies will look just like term insurance with zero cash value and a simple tax-free death benefit.
Ok, So What Do I Do Now?
That’s a great question! I’m telling my clients to stay the course, keep the policies they have, and buy term life insurance as a placeholder until the Trump presidency matures and we see where his tax plan goes in the next few months. Regardless of tax reform possibilities, if you need life insurance, then BUY life insurance. Don’t put off protecting the very family that means the world to you just because a tax change “might” happen. We all know that we have a finite time on Earth. We don’t know if tax change is inevitable, so plan accordingly. Now would be a very good time to review all of your personal coverage, especially disability insurance, which often overlooked! make sure you review your employee benefits at work for both spouses and make sure you both are protected adequately “just in case”… As always, please let me know if you have any questions or comments below. AND, by all means, get term insurance quotes at the button below!