As we navigate another tax season, we want to highlight some tax planning strategies that, if implemented today, could benefit you and your family for many years to come. Life insurance and annuities are two financial tools that, when properly utilized, can provide significant long-term benefits.
When you hear the word “annuity,” what comes to mind? If you are like many investors, it is a “free” steak dinner followed by a flurry of follow-up calls. My grandmother used to say, “When you live as a hammer, all the world is a nail.” This is what I think when someone comes into my office with an annuity that is not suitable for their situation, and they cannot even explain why they own it.
It's true, there are plenty of those seminars out there. But do not let the sizzle ruin the steak. Just like not all advisors are the same, not all annuities are either. Like other financial tools, annuities have a legitimate function and offer unique advantages. For example, consider their tax benefits.
Tax Deferral: Annuities grow on a tax-deferred basis, meaning you will not owe taxes on the earnings until you withdraw or surrender the contract.
Tax-Favored Withdrawals: When you annuitize an annuity contract, your payments are not only guaranteed but also made on a pro-rata basis, meaning they are part earnings (taxable) and part principal (tax-free).
Tax-Free Rebalancing: Similar to an IRA, taxes are only owed when money is withdrawn from the account, not when you change investments. If you want to rebalance your annuity contract, you will not owe taxes on the gains when you move money from one investment to another within the annuity.
Tax-Free Contract Transfers: Don’t like the annuity you are in? Has your situation changed, making a different type of annuity more suitable? One of the powerful benefits of these products is the ability to switch providers or change annuity types without triggering a taxable event. However, be cautious of surrender charges when considering this option, as they are contract-specific and can last longer than expected.
A life insurance policy is one of the few things you will buy that you hope you never have to use. There are many types of life insurance, and many are excellent ways to protect your family and business interests. Additionally, life insurance can offer valuable tax benefits.
Tax Free Death Benefit: Most death benefits from a life insurance policy are paid to the beneficiary income tax-free, which can be life-changing, especially with larger policies.
Loans Provisions: Life insurance policies with cash values, such as whole life or universal life, often include loan features that allow you to access your money as a tax-free loan. However, like any loan, it must be paid back. An unpaid loan balance could negatively affect the policy’s health and potentially trigger a taxable event.
Tax Free Return of Premium: Certain life insurance policies allow you to withdraw your cash value tax-free, up to the amount of premiums paid. If you have an older policy with a high cash value, this could give you access to a substantial amount, depending on your premiums. However, be aware that making these withdrawals will reduce your cash value and may negatively impact the death benefit.
Tax Free Contract Transfers: Similar to annuities, you can transfer the cash value from one life insurance policy to another via a 1035 exchange without triggering taxes. Some modern policies offer features like guaranteed death benefits and the option to use the death benefit as a ‘living benefit” to cover long-term care costs.
While both annuities and life insurance often receive negative press, they offer unique tax benefits that shouldn’t be overlooked. If you would like to learn more about these benefits, reach out to your Apella Financial Advisor.
Disclosures:
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