When you save money on taxes, your money goes further. Life insurance and annuities are two types of tax-advantaged financial vehicles that can help provide security for you and your loved ones. You might think of the two as opposites: life insurance provides a lump sum in return for a stream of premium payments, while annuities guarantee a stream of income in return for a lump-sum payment. Learn how the tax benefits associated with these products can help you save.
Life insurance allows for tax-free transfer of wealth.
A life insurance benefit is generally delivered to heirs free of tax. The main exception is in estates that are subject to inheritance or estate tax. Even in these cases, however, there are ways to keep a life insurance policy out of the taxable estate.
The other situation in which a portion of life insurance proceeds would be taxed is if they are held in an account for a period of time after the insured’s death. If the death benefit accumulates interest before it’s distributed to a beneficiary, then the interest received is subject to tax. Because a life insurance policy’s death benefit is generally tax free, many people use life insurance to pass more money down to their loved ones.
Tax deferral helps annuities grow faster.
Certificates of deposit (CDs) are popular because they’re safe savings vehicles that offer a guaranteed rate of return. In times of low-interest rates, however, those rates of return may not outpace inflation. As of February 2021, the top-earning CDs are boasting rates of 0.60–0.75%, well below typical rates of inflation. Annuities are often able to offer more generous interest rates.
Additionally, the earnings that money in a CD does generate are subject to annual taxes, further limiting the account’s growth potential. Unlike CDs, annuities are taxed only on withdrawals. Tax deferral is particularly beneficial for accounts that accumulate compound interest. When taxes aren’t taken out of an account each year, more money is left to earn interest over time, and the account is able to grow at a faster rate.
You can take a tax-free loan from a whole life insurance policy.
When you buy a whole life insurance policy, it accumulates cash value over time. Like the money in an annuity, this cash value typically grows tax deferred. You can access the cash value portion of a whole life policy by taking a loan against it. You don’t necessarily have to pay the loan back, either. However, any unpaid amount will be deducted from the death benefit. It’s also important to keep in mind that if you eventually surrender the policy or it lapses due to a lack of premium payments, the entire loan plus interest will become taxable.
ELCO Mutual offers a variety of whole life insurance policies and annuities to meet a range of financial needs. To learn more about these types of products, see our commonly asked questions or browse our blog.