I always get so excited when, let’s say for Labor Day, the hardware store has a tax free weekend. Dang! That’s the equivalent where I live of getting 7% off of that new hose and sprinkler. Seriously now, on any other day you can walk up to the checkout counter or the manager if you live in a small town like me, and tell them you’re really counting pennies right now and what is the best they they can do on your purchase and you’ll almost always get 10%.
So what’s the big deal with tax free life insurance? Does that mean if I pay $100 of premium on a policy per month that I’m not paying any sales tax on that? But where tax free really ends up being a huge, meaningful deal is on the far end (hopefully far end) when a life insurance death benefit is paid out. If everything is structured correctly and you don’t make the one mistake (I’ll get to those things in a minute) that can be made, your beneficiary gets that life insurance check for $500,000 (pick your figure) absolutely 100% income tax free. So it isn’t $500,000 minus whatever tax bracket you were in. Wouldn’t it be a drag to pay for $500,000 worth of life insurance only to have your beneficiary end up with $350,000 because of your 30% tax bracket? It’s been this way since life insurance started here in the US, and unless we end up with a bonehead President or Congress, it should stay that way. It’s about the beneficiaries and a compassionate government.
So, how can you mess up so your beneficiary receives less than 100% of the life insurance death benefit. The biggest mistake that is made is for someone, whether with business life insurance or personal life insurance to decide they deduct the premium that they pay for the insurance. In business this happens when they just mix it in with all of the deductible insurance costs. With personal insurance it could just be bulked into some deductible category like health insurance premiums or premiums paid for homeowner’s insurance on a rental property. Whatever the train of thought or method, if it is taken as a deduction it makes the entire death benefit taxable. Not good thinking when you consider the small net value of the deduction versus the huge net loss on the death benefit.
The other mistake that may not cost your beneficiary as much, but will definitely carry a price tag and slow down the paying of that benefit is if you don’t put down the actual beneficiary such as Jane Doe, wife, 100%. It doesn’t happen a lot anymore, but some people still think leaving life insurance proceeds to their estate works just fine. Uh, no! Estates go through probate unless they are held in a trust. If you have a trust for your estate and your intention is that the money is divided per the trust, you need to make the trust the beneficiary. More often people will pick a person as the primary beneficiary and, not having thought through what happens if you and your wife die in a common accident, or if your wife predeceases you, will put their estate as the contingent beneficiary. Oops!
Bottom line. The fact that life insurance proceeds are non taxable as income is the way it should be. The wrong government, hungry for money, could change that, but I can’t imagine they can make it retroactive. If you have questions or would like to get quotes, call or email me directly. My name is Ed Hinerman. Let’s talk.