7702

https://discussion.fool.com/7702-account-35159429.aspx?result=Ne…

Tax code section 7702 provides definitions on what actually constitutes a life insurance policy for tax purposes. Life insurance is not an investment, no matter what the salesperson claims.

AJ

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It is a life insurance that can be used as a vehicle to generate income. I am not so sure it is one for investment but it needs to gain in order to generate the incomes.
I think a portion of the gain can be taken out tax-free(like a Roth: taxed $$ in, tax-deferred growth, and tax free distributions) but the other portion that must be kept in the account would be decreasing as time goes by, and it would pay the beneficiary in the inevitable event of death with tax advantage.

I am still not completely familiar on how it works only to say that it could be used to generate tax-free income during retirement.

tj

I am still not completely familiar on how it works only to say that it could be used to generate tax-free income during retirement.

The ‘tax-free’ portion that you can take out is limited to the amount of the single premium you would have paid to purchase the contract. So essentially, you are taking your own money back out. It’s similar to buying stocks in a taxable account, and not having to pay capital gains taxes on the basis of the stocks when you sell. Except for life insurance, you pay a lot more in fees and commissions, and you have to pay ordinary income tax rates on the taxable amount, instead of capital gains rates on stocks that are held more than 1 year.

AJ

12 Likes

" Except for life insurance, you pay a lot more in fees and commissions, and you have to pay ordinary income tax rates on the taxable amount, instead of capital gains rates on stocks that are held more than 1 year."

yes there is a portion to pay the life insurance and a portion of cash value that you can take out. It is the same but when you take out the cash value you don’t pay any tax.

But this is at the expense of paying for a life insurance. I also read that the remaining cash value cannot be taken out by the beneficiary.

So you considered it and did not think it worthwhile?

I am trying to find ways to reduce potential taxes in retirement. I have a good chunk in taxable account now.
I may want to consider Roth conversions when my income drops as I go into retirement. The earlier I do it the more tax free moneys I can hopefully get as it has time to grow inside the Roth for later use or for passing on.

tj

So you considered it and did not think it worthwhile?

I have nobody else who depends on income that I generate, so I have never gotten any life insurance other than the life insurance that was offered through my job. I even opted down from the ‘no cost’ 2x my salary insurance amount to the minimum $50k amount because I didn’t want to pay the taxes on the imputed income for the premiums the company was paying for coverage over $50k.

That said, if I did need to purchase life insurance because someone else was dependent on my income and needed to have that income replaced, I would only ever consider purchasing term life. I have examined multiple types of life insurance and annuity contracts and have never found them to be financially beneficial to anyone but the salesperson and the insurance company.

I am trying to find ways to reduce potential taxes in retirement.

I’m retired, but my goal before I retired was to reduce taxes over my lifetime, not just ‘in retirement’ (see my comment on income on the imputed income from life insurance over $50k).

I may want to consider Roth conversions when my income drops as I go into retirement. The earlier I do it the more tax free moneys I can hopefully get as it has time to grow inside the Roth for later use or for passing on.

Roth conversions also reduce the Traditional balances, thus reducing the taxable RMDs when you reach that age. Strategically placing different types of assets (those that generate interest vs. dividends vs. gains) into the different types of accounts (tax-free vs. tax-deferred vs. taxable) can also help to minimize taxes.

AJ

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thejusticier:

AJ: {{{" Except for life insurance, you pay a lot more in fees and commissions, and you have to pay ordinary income tax rates on the taxable amount, instead of capital gains rates on stocks that are held more than 1 year."}}}

“yes there is a portion to pay the life insurance and a portion of cash value that you can take out. It is the same but when you take out the cash value you don’t pay any tax.”

It is not taxable because the insurance company is simply remitting your own money to you. And you will likely pay interest to the life insurance company for the privilege of using your own funds.

“But this is at the expense of paying for a life insurance. I also read that the remaining cash value cannot be taken out by the beneficiary.”

I do not follow. If the beneficiary collects the insured amount there is no cash value left to take out.

“So you considered it and did not think it worthwhile?”

I have one permanent policy because I wanted permanent insurance. All my other life insurance was term life in order to have the coverage amount I wanted at a premium I was willing to pay.

“I am trying to find ways to reduce potential taxes in retirement. I have a good chunk in taxable account now.”

The goal should not to pay the least amount of taxes; it should be to have the most funds left after paying taxes. too many people lose sight of the real goal, IMO.

“I may want to consider Roth conversions when my income drops as I go into retirement. The earlier I do it the more tax free moneys I can hopefully get as it has time to grow inside the Roth for later use or for passing on.”

The IRA v Roth IRA decision, ceteris paribus, really depends on your tax rate when you contribute compared to your tax rate when you withdraw.

Conversions in or near retirement is a more complicated decision that also can involve questions about taxability of SS benefits and also IRMAA payments for Medicare, among other matters.

Regards, JAFO

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Roth conversions also reduce the Traditional balances, thus reducing the taxable RMDs when you reach that age.

ROTH IRA conversions. ROTH 401Ks have RMDs.

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I have nobody else who depends on income that I generate, so I have never gotten any life insurance other than the life insurance that was offered through my job. I even opted down from the ‘no cost’ 2x my salary insurance amount to the minimum $50k amount because I didn’t want to pay the taxes on the imputed income for the premiums the company was paying for coverage over $50k.

Wow, AJ, you still teach me something every day. Now I know what that small “GTL” line item is on my paychecks - all these years and I have to admit I never really looked into it.

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Now I know what that small “GTL” line item is on my paychecks - all these years and I have to admit I never really looked into it.

GTL = Group Term Life

I did look into it, and opted down to the $50k level, as I didn’t need the policy. I even got a small credit back toward paying for other benefits with one of my employers.

Obviously, it wasn’t a huge tax impact either way, but why pay taxes on an unneeded benefit?

AJ

2 Likes

I am trying to find ways to reduce potential taxes in retirement. I have a good chunk in taxable account now.

Then your taxable account is still a better vehicle than cash value life insurance.

The main thrust of variable (cash value) life insurance harkens back to the days when dividends were taxed as ordinary income (prior to 2003). If you had high income and you wanted to defer taxes on your investment earnings and you had maxed out all of your retirement accounts, you had basically two options for further unlimited investments - variable life insurance or taxable investments.

When the tax rate on dividends changed to make them taxed far less than ordinary income, life insurance as an additional retirement vehicle lost the vast majority, if not all its benefit.

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