As was mentioned previously, this form of Whole Life Insurance builds a cash accumulation fund within the Life Insurance. The premiums are higher than a straight Term Life Policy. The large difference in premiums is largely due to the cash value. It’s like having two accounts in one, both the death benefit to buy-out a partners interest and a side fund that builds cash. So if the premiums cost more than why would you want this in a Buy-Sell?
First of all, consider the Life Insurance as an Asset class. I know it may seem strange but bear with me on this. With the excessive volatility we’ve seen over the years, it makes sense to many individuals and businesses to have some assets in a fixed, guaranteed account. This is especially true if you are a conservative investor. Currently the rates on a traditional Whole Life policy run approximately in the 3% range. While this is not high, keep in mind two factors. First it would be prudent to have some, not all, investible earnings in a fixed, guaranteed account. These policies while providing a death benefit also can help form a basis for a supplemental retirement plan.
In addition, although the interest earned ( approximately 3%) is low, it is tied to the current interest rate environment. For example, approximately twenty years ago the interest earned on such polices were 9% – 10%. It would be important to note that the cash value earned is in the form of dividends (if it’s a mutual company). Even more importantly this cash value dividend or a fixed cash account is tax-free up to the amount contributed into the plan. Tax free withdrawals can also be made. We will discuss more about this later. So you will not have to worry about being taxed each year as your cash value grows. As we are in a low interest rate environment today, I can safely say that at some point in the future interest rates will rise. This is of course if the economy follows the same sequence it has in the past. Every indication shows that it will. You may remember quite recently that there was a spike in short term rates.
Remember when we discussed a Trusteed Buy-Sell Plan? This is where you have a policy for each business owner but the TRUST owned the policies. This trust was also managed by a Trustee. Now there is a little quirk in the tax laws that state that if an investment in a trust earns interest, this earned interest is taxed at trust rates. OUCH! Not another tax?! However, if you have tax-free cash value accumulation, this is viewed as your cash buying paid-up additions within your Life Insurance. As such, there will be no taxable event to report. This is very important if you design a Trusteed Buy-Sell. Still keep in mind that when your form other Buy-Sell agreements, this cash value accumulation is still tax-free.
Again this is not suited for everyone but it is important that you look at all the options available to decide which plan best fits your needs. Next we will be discussing more applications on the cash value type of Whole Life plans.