Brought to you by Heritage Financial Consultants, LLC,
In conjunction with Lincoln Financial Advisors a registered investment advisor
Insurance generally is one of those items that you buy but hope that you’ll never need. Life insurance cash value, however, can be a useful asset that can offer additional income potential along with tax benefits. It also generally pays an income tax-free death benefit to your beneficiary upon your death along with the potential for tax-deferred growth of cash values. Life insurance is purchased subject to underwriting approval.
Evolution of Life Insurance
On a fundamental level, life insurance policies are simply contracts between an insurer and an insured to provide a death benefit in exchange for payment of premiums. Many individuals receive term life insurance as a benefit from their employers, although coverage usually ends with employment.
On the other hand, whole life policies, as the name suggests, provide coverage over your entire lifetime. Importantly, whole life policies also contain additional features such as a potential build-up of cash value, the ability to take out loans, and even participation in the earnings of the policy, even though the insurance company manages the investments.
Insurers set premiums payments based on long-term interest rate forecasts and actuarial assumptions about how long the premiums will be paid. During an era of high and rising interest rates, a variation on the whole life theme appeared in the form of universal life insurance.
With a universal life policy, the insured was able to pay a lower premium and establish an equivalent death benefit, allowing for a permanent policy with more flexibility than a whole life policy. During periods of higher interest rates, universal policy holders could see their cash values increase much more rapidly than those in whole life policies. But with lower interest rates, it meant the premiums have to work harder to generate the same rate of return, or else the cash value could decrease. Universal life policies perform well in a rising interest rate environment, but they can be less than ideal when rates are falling or in a low interest rate environment. Life insurance illustrated performance is based on specific assumptions and is never a guarantee or a predictor of future results.
A more attractive option for many individuals is the variable universal life policy. Variable Universal Life is most appealing to a wide range of people who are interested in the dynamics of death benefit protection and potential cash value growth through a choice of high quality investment options (sub-accounts). Variable life insurance has features of both traditional insurance products and securities.
The distinction between variable universal life policies (VULs) and traditional universal policies lies in your ability to select and manage policy investments, or “sub-accounts.” These sub-accounts, which can range from basic stock, bond and money market accounts from popular investment providers, have tax-deferred growth potential over time and may also generate tax-free income for beneficiaries.
The Big Idea: Tax Deferral
As you pay premiums and make sub-account investments with a VUL policy, you can potentially build up cash value in the policy, which can be used for a number of purposes. In fact, the major lifetime financial benefits of universal life and whole life policies are in the tax treatment of withdrawals and loans from cash value accumulations. Withdrawals from life insurance policies are usually taxed on a “first-in-first-out” basis. In other words, the amount you paid into the policy as premium (cost basis) is withdrawn first – then any taxable income. The amount withdrawn that exceeds the policy’s cost basis is taxable. Withdrawals from cash values reduce the death benefit and may be subject to surrender charges.
Loans and withdrawals generally provide tax-free access to funds that may be used for any purpose but will reduce the death benefit. No taxes are paid on cash withdrawals up to the extent that premiums are paid, and loans—which are not taxed as long as the policy remains in force—can be paid back out of the death benefit (which will be reduced for principal and interest outstanding). This assumes the policy is not a Modified Endowment Contract where cash values exceed a multiplier of the policy’s death benefit.
Variable universal life insurance involves investment risks, including possible loss of principal. Before investing, investors should carefully consider the investment objectives, risks, charges and expenses of the variable universal life insurance product and its underlying investment options. The current policy prospectus and underlying fund prospectuses, which are contained in the same document, provide this and other important information. Please read the prospectuses carefully before purchasing a variable universal life insurance policy.
Registered associates of Heritage Financial Consultants, LLC, are registered representatives and investment advisor representatives of Lincoln Financial Advisors Corp., a broker-dealer (member SIPC) and registered investment advisor, offering insurance through Lincoln affiliates and other fine companies. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances. The content of this material was created by Lincoln Financial Advisors for its representatives and their clients.