What is an Investment Grade Insurance Contract?
An investment-grade insurance contract, or IGIC, is a type of insurance that allows you to invest your money without paying taxes on its development while simultaneously allowing you to utilize it when you need it without paying taxes on the money you spend. This means you may save your money, earn interest, and earn interest on your interest while just sharing a small portion of it with the government.
You can also leave it to your heirs without having to pay taxes on it. So there are no taxes as it grows, no taxes when it is distributed, and no income taxes when the death benefit is handed on to your heirs.
The differences between IGICs and government-regulated vehicles like IRAs and 401(k)s don’t end there. IGICs, unlike typical retirement plans, do not expose investors to stock market risk while yet providing competitive returns. They don’t charge any fees for utilizing the money (and you have the option of repaying it), and it comes with a death benefit in addition to the monetary value. Furthermore, the death benefit is permanent and unassailable. There is no term that is set to end after a set number of years. It’s also free of charge.
Long-term care and chronic-care expenditures are another advantage. Because the death benefit is guaranteed, you may be able to spend a portion of it while you’re still alive to pay for assisted living or long-term expenditures.
Because this investment account was acquired with after-tax money, all of these tax advantages are accessible. So, rather of deducting your premium payments like you would with an IRA or 401(k), you would forego the immediate but little tax benefit of a qualifying account in return for significant and long-term tax advantages. Learn how investment-grade insurance contracts fit within a tax strategies plan.
In most circumstances, once your money is invested in an IGIC, it, its growth, and the death benefit will never be taxed again. There are a few of small exceptions, which we’ll go through later.
Your general health is a consideration in qualifying for this plan, just like it is for any other life insurance product, therefore not everyone will be eligible. However, you can be the contract owner but not the insured, thus this technique can still be used if you have an insurable interest in someone who is insurable, such as a spouse, kid, or important employee.
Why Haven’t I Heard of an IGIC?
Life insurance was almost solely used for, well, insuring lives for a long time. Its purpose was to provide for the survivors by replacing the deceased breadwinner’s income.
With cash-value life insurance, the insured not only purchased a death benefit, but also built up a cash reserve that could be used while they were still living, such as an emergency fund or retirement account.
However, because life insurance contracts offer significant tax advantages over other more typical investment vehicles, clever investors began to utilize it as a means of investing money rather than simply insuring lives.
Unlike a standard life insurance policy, which devotes the majority of the premium to the death benefit and only a small portion to the cash account, an investment-grade policy devotes far more premium to the cash value and very little to the death benefit. Instead of being set aside for your heirs, your money will be invested. It does, however, have the same tax protections as any other insurance contract because it is still an insurance contract.
So, what exactly are those tax benefits?
To best understand the advantages of an investment-grade insurance contract, it is vital to start with some simple terminology.
There are three stages of wealth accumulation. The first is the accumulation stage, where you are earning and putting away money into an investment. Next, is the distribution stage, where you are reaping what you’ve sown and can pull money out of the investment vehicle. And lastly, there is the wealth transfer stage, which is when you pass on what’s left of your accumulation to others.
During the accumulation stage of a standard retirement account, the government entices you to put money into a 401k, IRA, or other qualified account by promising to reduce your taxable income by the amounts you put into those accounts. In exchange, the government will not charge taxes on the amounts until you take money out at the distribution stage, but you must do it on government’s terms. So what exactly does that imply?
The average American pays around 12.5% in taxes. So, what the government is actually providing to the typical American is the following:
You’ll save $125 in taxes for every $1,000 you deposit into a qualifying account that year.
However, you may only contribute a certain amount each year (up to $6,000 for IRAs and $19,000 for 401ks in 2019)
The money you deposit into these accounts will be invested and should increase over time.
However, you are responsible for all of the investment’s risks. If the economy collapses and the value of your account is halved, you will lose 100% of your money
Then, when you’re 59.5 years old, you may start pulling the money out, and you’ll have to pay taxes on it as ordinary income.
However, if you take any of the money before you turn 5912, you’ll have to pay a 10% penalty as well as taxes on the withdrawal
Furthermore, you must pay taxes on the whole withdrawal, including the principle and all profits
You can keep the money in the account past 5912, if you want to optimize the growth.
However, whether you want to or not, you must begin drawing money out of the account at the age of 72, at which time it qualifies as income and is fully taxed
If you pass away while the account balance is still positive, the account is handed on to your heirs.
However, that sum is included in your taxable estate, and any money removed from the account will be subject to income tax.
Now let’s have a look at how investment-grade insurance contracts operate in a similar situation…
IGIC Accumulation Stage
You pay taxes first with an investment-grade insurance policy. After then, you must pay your premiums. That implies that for every $1,000 invested in insurance, the ordinary American will have already paid $125 in taxes. With a few exceptions, those are the only taxes they or their heirs will ever owe on this account.
Unlike a qualifying account, you are not restricted to investing $6,000 or $18,000 each year. There is no limit as long as there is an insurable interest.
And, although a qualifying account carries a significant financial risk, insurance contracts are risk-free. You’ll get a guaranteed minimum return on your investment (typically about 4–5% in compounded interest) plus non-guaranteed dividends, regardless of how bad the economy is doing.
IGIC Distribution Stage
While the distribution stage of a qualifying account does not begin until age 5912 (without suffering hefty penalties) and must be completed by age 72, the distribution stage of an insurance contract is completely flexible.
You can utilize the cash value of your account at any time, starting the day after you make your first premium payment and ending when you die. That is, at any moment, for any reason, and in any quantity (up to the accumulated cash value, which includes principal, interest, and dividends). There are no consequences for withdrawing early. There are no mandatory minimum distributions. It’s all about flexibility and freedom.
You can use the cash value either by withdrawing it directly from the account (this isn’t recommended because you’ll lose interest-earning potential and could trigger a taxable event), or you can can use it as collateral for a low-interest loan (which we highly recommend because if done correctly, the cash-value of your account will always earn more interest than what the loan accrues, and you’ll never owe money).
These loans are always tax-free, and cash value withdrawals are tax-free up to your cost basis (this is the amount you’ve paid in premiums throughout the policy’s lifetime). Dividends, likewise, are tax-free, unless your capital gains exceed your cost basis.
IGIC Transfer Stage
You’ll probably be pleased you placed your money into an insurance contract rather than a qualifying account when you retire and live off the riches you acquired throughout the accumulation period. Despite all of the benefits we’ve discussed so far, the insurance contract truly shines at the transfer step.
Both qualifying accounts and insurance contracts have cash value accounts that have built up over time. However, the insurance policy includes a lot more, such as a death benefit. A death benefit that is considerably greater than the amount you put into the account.
If you only have qualifying accounts, the remaining money in your accounts will be handed on to your heirs, who will pay taxes on it as regular income when you die. When you die, though, there are two accounts to consider with an insurance contract: the first is the cash account. You’ve been living off of that account to support your retirement (by taking out loans against the policy). This is your account, not your heirs’.
The death benefit, on the other hand, will always be larger (typically much greater) than the cash value. When you die, your death benefit is used to pay off any debts you’ve taken out against the cash value of your life insurance policy. The remainder is then handed on to your heirs tax-free.
How Do I Set Up an Investment Grade Insurance Contract?
Please give us a call!
When it comes to life insurance, the agent will usually decide how much coverage you require first. The agent will do a study to determine how much your heirs rely on your income and how much money they would require in a lump-sum payment to replace it. The account’s financial worth will be an afterthought. Because the majority of the commissions are derived from the policy premiums paid toward the death benefit, the insurance agent receives significantly larger commissions this way.
Instead, we start with how much money you want to/can afford to put away each month using an investment-grade insurance policy. Then, using the IRS’s insurance contract methodology, we create the contract with as near to the lowest death-benefit-to-cash-value ratio as possible. That way, you get the most of your money. Fees and commissions are kept to a minimum, yet you still get all of the advantages listed above because it’s still an insurance contract.
We Can Help Protect Your Money
There are a variety of options for setting up an investment-grade insurance contract, including long-term care, early access to the death benefit for terminal illness, accidental death riders, early paid up additions, and much more.
Bellvue Rush can assist you in correctly structuring your strategy.