Best Way to Pay for Life Insurance - Part 1

You may pay for life insurance in two ways. You may purchase off-the-shelf, retail, yearly renewable term life insurance and pay for it with your after-tax income, or you may place investment funds with the insurance company, funds in excess of what is required for the yearly renewable term insurance. The insurance company will invest those extra funds on your behalf and earn a return that will not be subject to income tax. The insurance company will then use a portion, or all, of this return to pay the annual mortality and expense charges required by your life insurance contract. You can choose to pay for life insurance with the pretax earnings on your investments within the insurance policy.

Under the first method, retail term life insurance, you would be paying for these same benefits with dollars that had been subject to taxation. This is better described in the "President's Tax Proposals to the Congress for Fairness, Growth and Simplicity" of May 1985. It explains what went on in congressional committee meetings on the proposal to impose current taxation on the inside buildup of insurance-a proposal that was not successful!

Thus, a policy-owner who pays a premium in excess of the cost of insurance and loading charges for the year in which the premium is paid is, in effect, making a deposit into a savings account that earns income for the benefit of the policy-owner. Current law permits life insurance policy-owners to earn this income on amounts invested in the policy free of current tax. This untaxed investment income is commonly referred to as inside build-up.

If a policy owner holds a life insurance policy until death, the investment income within the policy, which was not taxed during the insured's lifetime, escapes tax permanently as it passes to the beneficiary without income tax. A policyholder can avoid estate taxes as well as income taxes on the proceeds of the life insurance policy, the policy serves as a very efficient tool for the accumulation and transmittal of family wealth.