It has never been more urgent to take action to position your clients’ wealth for a rising tax environment. Whether you’re a financial advisor or a CPA, now is the time to broaden the conversation with your high net worth clients to go beyond returns and include the remarkable tax benefits of overfunded life insurance.
The current tax environment in the US has made tax reduction strategies critical for wealthy customers looking to maintain prosperity in the future. After an era of historically low taxes, tax rates can only go up. Before the Covid-19 pandemic, the US was faced with rising national debt totaling $ 22.8 trillion at the end of 2019. The pandemic further exacerbated the situation and resulted in more trillion-dollar reliefs related to Covid. The latest bill, passed in March 2021, added another $ 1.9 trillion to the balance sheet.
Such debts endanger our nation financially, and one of the easiest ways for the government to reduce the debt and its associated risk is to raise taxes.
The 2017 Tax Cuts and Jobs Act won’t expire until 2026, but lawmakers can choose to raise taxes earlier. Even if a change in the tax rate is delayed, tax rates are expected to rise in the coming decades. At the same time, the current political climate suggests that those likely to bear the brunt of the new taxes are those with higher incomes and higher accumulated wealth. In short, your high net worth clients now need a strategy to hedge against rising taxes.
Taking measures to protect against rising taxes is not a new concept. For high earners, the two most common strategies are:
1. Investment in Roth 401 (k) s and Roth Conversions.
2. Investing in managed portfolios in Health Savings Accounts (HSAs).
Unfortunately, both options are plagued by contribution caps. For clients who have the resources to invest more and who are focused on lowering taxes in retirement, overfunded life insurance offers a valuable third option. At the simplest level, life insurance offers the policyholder’s beneficiaries a death benefit. However, if properly designed, permanent life insurance can be converted into an alternative investment vehicle that offers income tax-free death benefit and tax-free growth on the policy’s present value. With recent changes in tax law, this option may be more attractive than ever.
Changes in tax law increase the investment power of life insurance
In 1984, Section 7702 of the Tax Code set a lower interest rate of 4% for all permanent life insurance policies in order to limit the tax advantages of present value policies. In particular, Congress changed the code at the end of 2020 and lowered the interest rate on the tax code to 2% as of January 1, 2021. The change was a huge win for life insurance carriers whose margins had been virtually erased in the extremely low interest rate environment. The biggest winners of all, however, could be high net worth investors who can now add overfunded life insurance to their portfolio to lessen the impact of rising taxes on their wealth.
For business owners and other high net worth investors, variable universal life policies (VULs) offer particularly powerful benefits, including the flexibility to invest the full cash value of a policy. greater growth potential than traditional cash or life insurance policies; and thanks to the amendment to section 7702, flexible rewards that allow the purchase of the lowest possible death benefit at the highest allowable premium. For highly conservative wealthy investors willing to forego some growth in exchange for the relative certainty of a more predictable return, Fixed Income Universal Life Policies (ULs) and Indexed Universal Life Policies (IULs) also offer tax savings opportunities.
Navigate the client conversation
As with most investment options, overfunding is not suitable for every investor. Customers most likely to be eligible for this strategy are investors in reasonable health who are committed to growing their assets and are focused on protecting their wealth in a rising tax environment, as well as small business owners who do not want or no longer want to implement a qualified retirement plan save than their qualified plan allows. To help these wealthy customers understand the benefits of overfunding a permanent life insurance policy, the following points can help illustrate the value of this strategy:
• Efficient retirement tool: Traditional IRAs and Qualified Plans offer tax-free growth but are taxable on distribution. In contrast, permanent life insurance offers tax-free growth and a tax-free source of income in retirement, and offers wealthy investors benefits on par with Roth IRAs, but with no income restrictions. By balancing tax deferred and tax preferred options, investors can create a more tax efficient income stream for retirement.
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