Life insurance is primarily viewed as a way for a family to safeguard their income in the event that a breadwinner passes away during their working years. It’s good if that’s the main reason an individual bought a policy. However, this income-replacement function does not have to — and probably shouldn’t — end with retirement.
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The tax benefits are what I love most about life insurance.
The tax code contains several provisions that provide life insurance income tax benefits and transfer tax benefits.
- Death benefits
Death benefits are usually paid income-tax free to beneficiaries. They may also be exempt from estate taxes if the estate remains below the taxable limit (11.4 million for singles and $22.8million for couples). However, state limits can be lower. These estate tax exclusions apply to all assets that you pass on to your heirs.
- Benefits for Accelerated Death
Benefits that are paid before the insured dies due to terminal or chronic illness are also exempt from tax. This option is called an “accelerated death benefit” (ADB). It is relatively new. ADB options may not be mentioned in policies that have been in place for many years by elderly people. If this option is offered, interested individuals should contact their life insurance provider. This coverage can be added to an existing insurance plan if it does not provide it. The insurance policy can have the additional benefit, but it may come at a price.
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An ADB allows policyholders to receive a portion of their death benefits in advance. This is a major benefit. This option has no major drawbacks. However, policyholders must be either terminally ill or chronically ill to receive an ADB. Policyholders who need care have other options, including those who are terminally ill or chronically ill and those who aren’t.
- Cash value
Permanent life insurance policies allow cash values to grow without income tax. Cash values that exceed the policy owner’s tax base can be borrowed income-tax free as long as the policy is in force. However, there are some drawbacks to this. The death benefit to your beneficiaries is deducted from the policy loan’s loan balance if you die before the interest has been paid. If your beneficiaries require the full amount of the benefit, this could cause problems. The interest accrued on a loan that is not paid is added to its principal balance.
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- Competitive fees
You don’t want life insurance to cost you more than it is worth. However, fees that are properly structured can be very competitive. The fees include surrender charges, administrative costs, and sales charges. There is also the underlying cost of insurance. While the initial cost is relatively low when you are young, it increases as you get older. Brightscope estimates that the average annual total expense for large-company 401 (k) plans is 1% of the account balance.
The expense ratios for mutual funds can be as high as 1.5% to 2.2%. Many mutual fund investments can cost between 2.5% and 3% annually. This does not include transaction fees, which are charged when the money manager purchases and sells within the fund.
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- Explore all options
Even if you’re not working, that doesn’t mean that you don’t need the benefits and protections life insurance can provide. Start by researching the benefits that the right policy can offer as part of your retirement strategy. It’s like any other investment. You need to determine your needs and find out as much information about insurance companies as possible. Then, get referrals for specialists who will help you understand the pros and cons of different policies.