Alternative Tax Free Income for Physicians

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When is the right time to use a life insurance contract as part of your financial plan

Cash-value universal life insurance contracts are an often overlooked investment vehicle that can offer physicians tax-efficient, low-risk wealth accumulation. As you weigh the value of a life insurance contract in comparison to other financial products, it is helpful to compare the long-term difference between paying insurance policy charges versus paying taxes on alternative investments. 

Setting up a Life Insurance Retirement Plan with universal life insurance products contain both a death benefit as well as a cash-value equity index account. When you fund your contract, a portion of the contributions goes to the insurance costs, while the rest accumulates cash value within the contract. Over time, this cash-value yields returns in proportion to a designated index (such as the S&P 500 or the NASDAQ-100). As long as your contract is properly structured and managed, you can access both the cash-value and its gains in the form of tax-free distributions during retirement. These distributions are actually advances from the contract’s insurance benefit which gradually reduce the death benefit. Provided that that the account is maintained until maturity, the withdrawals, advances, and payouts from the contract are all tax-free. In most cases, these tax savings substantially outweigh the cost of the policy’s charges and fees. 

When discussing life insurance contracts for retirement investing, it is important to understand that not all contracts are designed equally. Universal life insurance contracts are exceptionally flexible financial products that can be customized to the needs of individual investors. However, when you purchase a retail policy from a traditional life insurance agent, don’t expect to get the benefits of this flexibility. Most “off-the-shelf” policies are not designed for cash-value accumulation, and instead include too much insurance, frivolous administrative charges, and excessive management fees. If you’re considering using a cash-value life insurance contract as an investment vehicle, it is essential to purchase and structure your contract under the advisement of a financial planner working a fiduciary capacity. A financial professional can compress fees, incorporate premium financing, and often provide access to proprietary financial products with favorable terms that are not available through traditional agents. As we discuss the best ways to utilize and evaluate cash-value life insurance products, we only advise physicians to consider products that are structured and managed by a specialized financial planner. Traditional retail life insurance policies are inefficient, inadvisable retirement vehicles. 

Related: Life Insurance for Retirement: The Right (and Wrong) Approach

Cash-value Universal Life vs. “Buy Term and Invest the Difference”

In the sphere of financial blogs and forums, it is not uncommon to encounter commentators (usually not financial professionals) who strongly dislike the use of life insurance contracts as investment vehicles. One of the most common objections from these detractors is that policy charges are too expensive. Instead, they often recommend buying a cheaper term life insurance policy and investing the difference in a traditional brokerage account. As you consider the potential value of cash-value life insurance, it is important to unpack these critiques. 

When you invest in a taxable brokerage account, you will pay taxes on any realized gains or income generated in your portfolio. By contrast, when you put that same money into a cash-value life insurance contract, some of the money will go towards policy charges, but there will be virtually no tax burden from the investment. As long as the contract is designed and maintained properly, you will not pay taxes on the gains realized within the policy, nor the distributions from the policy. The tradeoff is simple: taxes vs. policy charges. So the important question is, how do these costs stack up over time?

With products such as Variable Universal Life Insurance (VUL), you can choose to invest the cash-value of your contract into a designated account that is virtually identical to various mutual funds and brokerage accounts. This makes it relatively easily for an experienced financial consultant to illustrate the projected costs and benefits of both strategies over time. While the specific numbers will vary depending on the structure of the account and the underlying investment component, there are several key trends that can be observed in these comparisons:

  • Cash-value life insurance is more expensive in the early years. Universal life insurance has front-loaded charges in the first 7-10 years of the policy. During these years, there is no question that the policy charges outweigh the tax savings. It is important to remember that these policy charges are not pure expense; they are funding the contract’s death benefit. Over time, these policy charges decrease sharply.
  • With a properly structured life insurance contract, the most costly policy charges will drop-off in the first ten years, leaving only the cost of minimal insurance charges. Buying term life insurance and investing the difference costs more over time. In contrast to the universal life insurance approach, the “buy term and invest the difference” strategy costs investors more over time. If you purchase term life insurance, and invest the rest of your disposable income into a traditional brokerage account, you will be paying for the term policy premiums as well as the taxes on gains from your investment. This tax burden only increases over time as the returns on your investment increase. Meanwhile, returns on the same product within a VUL policy would not be subject to taxes. 
  • The crossover point usually occurs in the first 7-13 years of the cost projections. When financial planners compare the cost-benefit analysis of universal life insurance versus buying term life insurance and investing the remainder, the cost of taxes and term premiums begin to outweigh UL policy charges after the first decade or so. For this reason, cash-value life insurance is best utilized as a long-term retirement investment. When you compare the two investment strategies over the course of 20 or 30 year periods, universal life insurance virtually always emerges as a more efficient, lucrative financial product.
  • Related: 5 Tax Planning Strategies for Physicians (2020 Edition)

See the comparison for yourself

Our team of financial planners works with physician clients everyday to help them understand and evaluate the costs and benefits of various financial products. When comparing the tradeoff between policy charges and taxes, we find time and time again that universal life insurance contracts offer more efficiency and tax-free growth for high-income investors. However, you don’t just have to take our word for it. By working with a financial consultant, you can personally explore and compare the cost elements of cash-value life insurance contracts and alternative investments over time. 

As you consider the long-term benefits  of cash-value life insurance, it is important to work with an experienced financial planner. Many financial groups negotiate directly with insurance carriers to provide their clients exclusive access to products with low fees and highly favorable terms. Based on your income, risk tolerance, and preferred investing schedule, a financial planner can customize and compare different insurance products that may suit your needs. When the costs and benefits of various investment approaches are clearly laid out for comparison, you can make informed, strategic investment decisions for your financial future. 

Cash-value life insurance is not a simple, one-size-fits-all solution for all investors. These products are complex, flexible, and best managed with careful fiduciary guidance. However, too many physicians write-off life insurance as a retirement investment vehicle due to fear of exorbitant policy charges, before seeing the actual cost comparison for themselves.  For high-income investors who are looking to compliment their employer-sponsored retirement accounts, cash-value life insurance offers longer-term tax efficiency and valuable retirement income. 

To learn how cash-value life insurance and other retirement investments could bolster your financial future, talk with one of our physician-specific financial consultants today.

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