Finding money to pay for life insurance and providing two tax advantagesArticle added by Ken Davis, CPA, CFP, CLU, ChFC on April 24, 2012
Ken Davis

Ken Davis, CPA, CFP, CLU, ChFC

Fountain Hills, AZ

Joined: November 23, 2009

So, where can we find the money to fund cash value life insurance? In qualified plans, especially if the plan participant has a poor health rating.

People know they need life insurance; they just do not like to pay for it with their discretionary income. That is why we all know that if you can move money from one part of their personal balance sheet to another, without taking their liquid cash, they are much more likely to buy the insurance they need.

And if you can sweeten the pot with a tax deduction, then that works even better. So, where can we find the money to fund cash value life insurance? In qualified plans, especially if the plan participant has a poor health rating.

For example, your client Sam is rated table D. He has a small business and has an old SEP IRA plan of which he is the sole participant. He is short on cash and complaining about the high cost of his life insurance premiums. You want to make the sale, but he will not budge. What can you do?

Set up a profit sharing plan that allows for the purchase of life insurance. Then role the SEP-IRA into the PSP. Unlike the SEP, the PSP allows for the purchase of life insurance.

Now use the money in the account to purchase that sub-standard life insurance policy on your client. You just showed him how to pay for it without using discretionary funds that he wants to spend on himself and his family. But it gets better.

The other thing that motivates clients to take action is tax benefits. So how does this strategy do that? The tax law treats this kind of life insurance purchase as though it is a split interest ownership of the policy. The PSP owns the cash value and the participant owns the pure insurance piece. So, the government says the participant has to be taxed on the economic value of the pure insurance.

The good news is, and here is where Sam gets his big tax break, the taxable portion is based on standard life insurance rates. So, the excess insurance cost in the policy for the sub-standard rating has essentially become a tax deductible cost to Sam and he is not taxed on the economic value of this cost — ever.

Simply put, Sam gets a deduction for the contribution to the plan. The plan reports income only on the standard cost of the pure insurance, and not the sub-standard rates. And the life insurance proceeds come out to the participants family tax-free at death.

I know this is bit difficult to process through, but there are resources to help you get this type of stuff done. It will cost your client some administration fees and some patience. But, business people love to save taxes, and the deductibility of the sub-standard insurance costs will help take the sting out of your client facing their poor health rating and higher costs.

The tax laws are a more involved than discussed here. For example, you can go online to www.irs.gov and search for Publication 590 to read about rolling IRA money into qualified plans. Advice straight from the government’s mouth!

Or, message me if you have questions.

This information is offered to help you conceptually design and make a sale. The tax laws are complex and neither of us can be the tax expert on these transactions. So make sure your client engages independent tax counsel any time you are involved with a transaction like this.
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