Life Insurance As A Long-Term Financial Strategy

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OCEAN CITY — Last week we began our look at the changing face of life insurance, and this week let’s continue.

Whether you use an Irrevocable Life Insurance Trust (ILIT) or not, purchasing life insurance as part of an inheritance should be part of a comprehensive financial strategy. Unlike many other investment vehicles, an insurance policy will lapse if you stop paying premiums —meaning you can lose what you’ve already put in.

“Often couples will wait a few years after retiring before establishing an ILIT, when they know how much they are spending on their retirement lifestyle and what their excess income is each year,” says Gothers.

The funding for an ILIT might come from an IRA’s required minimum distributions, income from municipal bonds or dividend income, for instance. Potential future expenses also need to be considered before committing to paying the life insurance policy’s annual premiums.

Life insurance doesn’t have to benefit only your heirs. You can use a life insurance policy as a tax-advantaged investment vehicle to provide cash during retirement or for other liquidity needs, such as college tuition. “A permanent life insurance contract has all the advantages of a Roth IRA but none of the limitations,” says Gothers.

Like a Roth IRA, you invest after-tax dollars. You pay the premiums each year and have the option of investing additional premiums that grow tax-deferred and can be withdrawn or borrowed free of income tax. When funds are taken from the insurance contract’s cash value, the basis, or premiums paid, is taken first. Since premiums are paid with after-tax dollars, the funds are withdrawn tax-free.

When the basis is exhausted, additional funds may be taken via loans if there is sufficient value in the policy.* Because the event is a loan, it is not a taxable event. Also, there are no income restrictions that may make you ineligible to contribute, there are no set contribution limits, and the additional 10% income tax will not apply if you tap the funds before you’re 59½.

Although life insurance can be a vehicle for tax-efficient investing, it is, first and foremost, life insurance. The federal tax laws require that you maintain a death benefit in the contract to get the full tax advantages, which means you can’t withdraw the policy’s entire cash value. “You also have to keep the contract until you die, and policy fees are still taken from the cash each year, even though you may no longer be paying premiums,” says Gothers.

Fees, including the cost of insurance charges, an annual investment management fee, and a mortality and expense charge, can be 2% per year or even higher. But the flexibility of life insurance makes it a useful asset.

There are many types of life insurance available. Some products potentially build cash value. The cash value can build in a variety of ways depending on the type of insurance policy: It can build through the insurance company’s general account that typically has a periodically declared fixed interest rate; it can accumulate dividends; or it could grow through underlying investment options embedded in the polic

“Life insurance is complex, so before you use it for estate or retirement planning, discuss it with your financial advisor, who can make sure the features of a particular policy are right for you,” Gothers notes. “When life insurance is part of your overall long-term financial strategy, it can enhance your own financial security as well as that of your heirs.”

(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)

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