Permanent life insurance can serve as asset class in a well-diversified portfolio
Key takeaways:
- Real estate and life insurance offer the ability to perform tax-free exchanges.
- Real estate and cash value insurance have inherent ongoing costs associated with them.
Permanent life insurance shares notable characteristics with an asset class many physicians own — real estate — particularly in the realm of tax advantages.
Both can be considered “tax-favored asset classes” due to the significant benefits they offer under current tax laws.
Real estate owners enjoy several tax deductions, including depreciation on business properties, mortgage interest write-offs, and up to a $500,000 capital gains exemption on the sale of a primary residence for married couples filing jointly.
Permanent life insurance provides tax-deferred growth on cash value, allowing policyholders to access these funds tax-free during retirement. Additionally, the death benefits from these policies are generally exempt from income tax and can be structured to avoid estate taxes when placed in trusts.
Advantages
Both real estate and life insurance offer a unique advantage: the ability to perform tax-free exchanges. Under the tax code, real estate transactions can utilize section 1031, while life insurance can leverage section 1035 for exchanges without immediate tax consequences.
Let’s take a closer look at permanent life insurance as an asset class.
First, let’s consider three reasons to use permanent life insurance in your financial plan:
Tax-favored wealth accumulation. Permanent life insurance policies allow cash values to grow on a tax-deferred basis. Withdrawals made during retirement can be tax-free, in contrast to qualified retirement plans, which are subject to ordinary income tax upon withdrawal. This feature provides valuable tax diversification, especially for long-term retirement planning.
Asset protection. Permanent life insurance is classified as an exempt asset in many states. This provides a high level of protection against creditors. Furthermore, many states offer unlimited protection for cash values and death benefits, making permanent life insurance a key component of asset protection planning.
Estate planning. Permanent life insurance is vital for estate planning due to its liquidity. It provides immediate cash to beneficiaries upon the death of the insured, allowing for the settlement of debts or the distribution of wealth. Typically, the proceeds are paid out income-tax-free and can be structured to be estate-tax-free with the proper use of trusts.
Another benefit of permanent life insurance is it can serve as a source of low-cost cash. Even high-net-worth individuals can find themselves needing substantial loans for investments or unforeseen expenses, such as tax payments, medical bills or tuition. Selling assets to generate cash can lead to significant capital gains taxes, which diminishes the net benefit of the sale.
With a permanent insurance policy individuals can access cash by borrowing against the cash value of the policy with no tax liability, and often at a low rate or no cost at all. Real estate investors frequently use this approach to leverage their properties for additional investments.
Who uses permanent life insurance?
High-net-worth individuals. Many affluent individuals, including physicians, incorporate permanent life insurance into their financial plans to leverage its tax benefits and asset protection features.
Corporations and banks. Many corporations invest in permanent life insurance through a strategy known as corporate-owned life insurance (COLI). This strategy helps finance employee benefits and manage liabilities. For instance, as of mid-2023, U.S. banks collectively held more than $205 billion in cash surrender value from these policies, highlighting their significance even among major financial institutions.
Utilizing like-kind exchange tax benefit
As previously mentioned, both real estate and cash value life insurance enjoy a powerful tax benefit that few other asset classes are afforded: the ability to move from one piece of real estate/life insurance policy to another using a tax-free like-kind exchange.
In addition to their similar tax benefits, both real estate and cash value insurance have inherent ongoing costs associated with them. Most relevant here are the interest cost of a mortgage for real estate and, with life insurance, the mortality and expense costs of insurance (COIs).
Both of these costs are incurred and change over time. The key is to monitor and position yourself advantageously if the market changes to benefit you. We see this tactic as common-sense wisdom when it comes to real estate — the ubiquity of real estate owners refinancing their mortgages when interest rates fall. How many permanent life policy owners do the same with their policies — changing to a new policy to take advantage of new conditions?
In fact, there are a host of reasons one might want to like-kind exchange from one permanent life policy to another — five are highlighted here:
Industry-wide COI reductions. As people live longer, COIs drop, making today’s policies less costly. If you can still qualify for a top underwriting rating, you may have the most to gain by exchanging into a new policy to “revive” a lower COI structure.
Cost structures between companies. Separate from the specific COI expense, insurance carriers vary in their overall product pricing structures, so exchanging from one carrier’s products to another can create additional long-term cost savings.
Moving to policies with lower “access costs.” If part of your strategy in owning a permanent life policy is to access cash values, “access costs,” such as policy loan interest charges, are just as important as accumulation costs. If you can move to a lower access cost policy, the income benefits can be significant.
Moving to mutual insurance companies. Mutual companies are owned by the policyholders, who will likely get the benefit of future COI reductions, as opposed to policies issued by stock companies, where these savings may just mean more profits for shareholders.
Taking advantage of new product features. Policy elements — such as return multipliers, index participation rates, long term care riders and benefit distribution riders — are new to the industry over the past few years and can be extremely beneficial for the right policyholder.
Conclusion
Permanent life insurance serves as a powerful asset class, providing tax advantages, asset protection and strategic benefits in estate planning. By understanding its similarities to real estate, you can effectively incorporate this financial tool into your broader wealth management strategies, including the tactic of like-kind exchanging from one policy to another.
With careful planning and guidance from an experienced advisor team, permanent life insurance can play a vital role in achieving long-term financial goals.
Reference:
https://www.bolicoli.com/bank-owned-life-insurance-facts-and-figures/. Accessed: Feb. 14, 2025.
For more information:
David Mandell, JD, MBA, is an attorney and co-founder of the wealth management firm OJM Group www.ojmgroup.com, where Michael Lewellen is a partner and director of financial planning. They can be reached at 877-656-4362 or mandell@ojmgroup.com.
Mandell and OJM Group partners are pleased to announce the publication of their newest book, Wealth Strategies for Today’s Physician: A Multi-Media Playbook. The playbook’s innovative format features more than 90 links to videos and podcast episodes to enhance important financial topics for physicians. To receive a free print copy or ebook download, text HEALIO to 844-418-1212, or visit www.ojmbookstore.com and enter code HEALIO at checkout.
Collapse
Read more about