Monday, 27 May 2019

This source of tax-free cash can sweeten or ruin your retirement – CNBC

Glenn Daily, age 65, may have found the golden goose.

He’s sitting on a pot of cash that not only accrues interest; it can also be tapped tax-free.

The New York-based fee-only insurance consultant has held onto an insurance policy that his parents first purchased for him when he was just 12 years old. Each year, he pays $253 to keep it in force.

It’s known as a whole life contract — it requires him to pay fixed premiums and offers a tax-deferred interest-bearing account, known as cash value.

For now, the cash value of the policy is about $32,000 and grows at a rate of about 4 percent.

“If you think of this as a fixed income investment, where can I get that?” asked Daily. “Banks are proud to advertise 2 percent on a CD, and here I am getting more than 4 percent.”

He has also tapped that cash in the form of a $27,000 loan, which he has taken free of taxes at an interest rate of 3.7 percent. Daily pays the interest every year and intends on repaying the debt.

Done properly, a tax-free loan on life insurance can offer investors a source of liquidity and tax-free income in retirement.

Done incorrectly, that lifeline can trigger a tax landmine and destroy the insurance policy altogether.

Here’s what you should know about taking a tax-free loan from cash value policies.

While term insurance covers you for a limited period of, let’s say, 10 or 20 years, so-called permanent life insurance tends to be the tool of choice to protect your heirs from estate taxes.

That’s because the coverage remains in place as long as you keep paying the premiums and the death benefit is generally paid out free of taxes.

Permanent life insurance also includes a cash value savings account, which can grow in a range of different ways, depending on the policy.

Whole life offers a cash value account that grows at a guaranteed rate of interest that’s set by the insurance company. Some insurers pay a dividend, which clients can use to purchase additional coverage. Customers pay a fixed premium for the duration of the policy.

Universal life also has a cash value account that grows based on a minimum interest crediting rate that’s established by the company. If the insurer’s own underlying investments fare well, the company may pay additional interest toward your cash value.

Customers pay flexible premiums with universal life insurance, which means that you may be able to skip premium payments as long as your cash value is sufficient to cover the policy’s costs. Companies also offer different varieties of universal life, sometimes pegging the cash value’s growth to an index, for instance.

Variable life links the growth of your cash value to underlying investments known as subaccounts. These subaccounts are similar to mutual funds and you can decide how to invest.

Expect to pay more than you would for simple term insurance in order to obtain permanent coverage.

A healthy 50-year-old man may pay $21,483 per year for a whole life insurance policy with $1 million in death benefits, according to NerdWallet.

He would pay $1,692 annually for a 20-year term policy with the same death benefit, the personal finance website found.

Here’s how the strategy w