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Play up the tax benefits of permanent whole life: understanding the features about life insurance as property, as well as how those options can work in the best interest of policyholders, can lead to future sales.


In these tough economic times, there are few guarantees. Talk of the financial crisis has everyone on edge. Millions of Americans have lost retirement savings that took years to build, while simultaneously, the market continues to fluctuate. The sub-prime mortgage crisis has caused foreclosures at alarming rates. Jobs losses have surmounted to their highest levels in years. All the while, many are asking, will things get worse before they get better?

During this uncertainty, it's hard to find good news in a mountain full of bad. However, if ever there was a silver lining in a fog of clouds, it would be in knowing that for clients with a need for life insurance, permanent coverage remains a solid choice. Along with providing the necessary death benefit protection your clients need, life insurance can provide other meaningful tax benefits during the life of the policyholder.

According to LIMRA International, 68 million Americans have no life insurance at all, and those with some coverage have far less than what most experts recommend to ensure financial stability for their families. In fact, LIMRA estimates that ownership of life insurance has been declining for decades and the impact is being felt in very human terms today. When a loved one dies without adequate life insurance coverage, surviving family members often face very difficult financial consequences, such as working additional jobs, facing longer years on a given job, having to borrow money from friends and family, moving to smaller, less expensive housing, or having to put a child's education on hold.

With so many Americans in financially vulnerable situations today, it just makes good sense to carry life insurance. Yet almost three out of every five Americans have not purchased life insurance because they think it is too expensive. This despite the fact that policy costs have remained stable or even dropped over the past decade, according to the Insurance Information Institute. Furthermore, consumers responding last year to a Life and Health Insurance Foundation for Education (LIFE) survey entitled, "Three Most Common Excuses," found that consumers who had not bought life insurance felt they did not know enough to purchase a policy.

"If someone relies on you financially, you need life insurance," said Jeanne M. Salvatore, senior vice president and consumer spokesperson for the Insurance Information Institute in a Jan. 2009 press release. "The premiums are very reasonable when you consider the level of protection you receive."

Know your tax features

As an insurance professional, you know that selling the protection of life insurance serves a purpose beyond business. But besides knowing how to make the initial sale, understanding the simple features about life insurance as property, as well as how those options can work in the best interest of policyholders throughout the lifecycle can lead to future sales. Just consider the facts.

"Remember, life insurance is the easiest asset--if you make a mistake--to give the IRS a big pay day when you finally check out," says tax accountant Irving L. Blackman in his column, "How to win the life insurance tax game" in the Jan. 17, 2008 issue of Contractor Magazine.

As anyone knows, the circle of life is made up of a series of events, some foreseen and others not. When it comes to permanent whole life insurance, during the life of a policyholder, there are many important tax features, including the following three:

1. Tax-deferred accumulation of policy cash value

With tax-deferred accumulation of policy cash value, a policyholder is not required to report any gains to the government. Additionally, tax deferral has the effect of increasing rate of return, when compared to annually taxable investments.

2. First In/First Out (FIFO) tax treatment of policy withdrawals

FIFO tax treatment of policy withdrawals allows distributions to be treated as a return of premium first. This applies until the amount distributed equals the adjusted basis in the policy. In cases where distributions equal the basis, a non-taxable loan may be taken. Care should be taken not to overburden a policy with loans as loans will reduce the death benefit, and excessive loans may trigger the need for additional premium to avoid lapse. However, when properly managed by an informed client and his insurance professional, a permanent whole life policy is a powerful tool that can help your client reach his objective.

FIFO treatment also carries other benefits when it comes to student financial aid eligibility and provisional income for Social Security. Non-taxable life insurance withdrawals are not reported as income on the Free Application for Federal Student Aid (FAFSA) form and are also not provisional income for the purpose of taxing Social Security benefits.

3. The avoidance of the 10% tax penalty

The avoidance of the 10% tax penalty on modified endowment contracts, annuities and qualified plans when a policyholder withdraws funds before age 59 and a half, this tax does not apply to permanent whole life insurance distributions, even if the distribution is subject to regular income tax.

Security blanket

Despite the death of a policyholder, life insurance benefits keep on giving, hence the reason agents sell it--to protect the living. Features such as a death benefit in excess of account value, exemption from state death taxes, avoidance of probate and offering tax-free income to beneficiaries can all help a family sleep soundly, knowing that they will have a measure of protection long after a loved one has passed.

"Life insurance is a security blanket that can help people prepare for the unexpected," says AUL producer Don Turner, based out of Austin, Texas.

Turner witnessed this personally in 2007 when a long-time client and friend contacted him to report she had been diagnosed with cancer. The client passed away in 2008, but according to Turner, because she created a legacy though permanent life insurance, she was able to provide for her two adult children and grandchild.

"Often enough, people cannot provide a legacy on assets alone," Turner explains. "That's why I advocate the tax benefits of owning life insurance and why I often say that part of the training for life insurance sales should include witnessing a death claim. Aside from seeing the benefits of ownership, you're able to see that the initial investment can lead to a payout that is worth more than the actual account value. That provides reassurance for the living."

Avoid state death taxes, probate

Another benefit life insurance provides upon a policyholder's death is the exemption from paying state death taxes. While state laws will vary, numerous states have retained separate estate or inheritance taxes. However, most states exclude life insurance death proceeds from the tax.

Using Indiana law as one example, if $500,000 in securities were passed along to an adult child upon the policyholder's death, an inheritance tax of $14,250 would be incurred. But, if $500,000 were to be passed on to an adult child as life insurance death proceeds, the beneficiary would not be required to pay any inheritance tax. (This example assumes a Class A beneficiary under I.C. 6-4.1-5-1 and exemption of I.C.6-4.1-3-10 in effect on 4-1-09 and that the securities are the only funds inherited. Life insurance death proceeds are exempt pursuant to the provisions of I.C. 6-4.1-3-6)

In cases where there are probate assets as part of an estate, such as a home, the land that it sits on or other valuable items, probate may be necessary to provide a beneficiary with a clear title. However, the probate process does have its disadvantages. First, it can take a year or more to pass though the legal system. Probate property is subject to the claims of creditors of the estate, such as debt holders, medical and funeral providers and taxing authorities.

Indeed, the combination of inheritance taxes, attorney and executor fees, court filing costs and creditor claims can take a surprisingly significant portion of an estate. Some states prescribe that attorney's fees shall be billed at an hourly rate subject to court approval. Other states may permit the assessment of attorney and executor fees as a percentage of the probate estate.

Yet, in cases where life insurance is paid to a named beneficiary, delays and costs associated with probate are avoided.

Finally, death benefit to beneficiaries of a life insurance policy is income tax-free. This is in sharp contrast to Income in Respect of a Decedent (IRD) property such as qualified retirement plans and IRAs that are typically fully income-taxable to a beneficiary. Additionally, the income tax-free nature has the potential to raise the rate of return when the death benefit is compared to a taxable investment.

Communicate the tax benefits

There are important factors one must consider when selling permanent whole life insurance. As your clients' personal situations change, so will their life insurance needs. Care should always be taken to ensure that strategies and products are suitable for long-term life insurance needs. You should weigh your clients' objectives and time horizons when recommending life insurance products.

Although times are tougher today and perhaps you've heard a few clients say they've decided to scale back on expenses by dropping their life insurance coverage, the truth is there has never been a better, more appropriate time than now to carry permanent whole life insurance, if for no other reason than to provide peace of mind for your dependents.

Furthermore, as an agent who sells life insurance, you have a unique opportunity to build your business by selling not only a true sense of security, but also to further communicate the tax features and benefits that accompany a permanent whole life insurance policy. As the national legend Will Rogers said way back when, "If a man doesn't believe in life insurance, let him die once without it. That will teach him a lesson."

David A Gresham, JD, CLU, CHFC, is Advanced Markets Analysis Manager with OneAmerica Financial Partners in Indianapolis. He provides support to a national field force with estate planning, retirement planning, business planning, and technical issues involved with product sales. He also authors position papers regarding advanced markets concepts and assists with the development of sales ideas and selling techniques. Gresham conducts education seminars nationally for the member companies of OneAmerica Financial Partners and has been a guest speaker for numerous industry organizations.

By David Gresham, JD, CLU, ChFC

American United Life Insurance Company, a OneAmerica company
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Title Annotation:New Directions in Life Insurance
Author:Gresham, David
Publication:Life Insurance Selling
Date:Jun 1, 2009
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