Will Congress Change the Tax Rules for Whole Life Insurance?

A growing segment of the financial industry is coming to appreciate the robust benefits of life insurance as an asset class. Besides the obvious death benefit protection for one’s heirs, a suitably designed Whole Life policy provides “living benefits” such as the contractually guaranteed ability to borrow (on very favorable terms) against the underlying cash value of the policy.

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Many households and businesses are particularly interested in the appealing tax treatment of Whole Life policies if they are designed and handled properly. Specifically, although the premium payments are after-tax dollars, the internal buildup of the cash value in the policy does not trigger tax liability, and the death benefit typically passes to the named beneficiaries without income tax liability. Moreover, while alive, the policyholder can effectively access the cash in the policy by combining dividend withdrawals and/or policy loans. Again, if handled properly, this activity will not trigger income tax liability under current rules. (In this article, I am giving an overview of the general environment; the reader should consult with qualified tax professionals before taking action.)

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When the above features of Whole Life insurance are explained to people for the first time, a common reaction is a combination of disbelief and then fear. At first, it seems too good to be true — what’s the catch? But after this initial doubt is resolved, a new worry arises: If too many people start doing this, won’t Congress just change the tax code?

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Now, to be sure, no writer — including me — can guarantee what Congress may or may not do in the future. But here are three reasons that fear of future changes to the tax rules shouldn’t inspire hesitation in pursuing one or more Whole Life policies for a household or business.

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Reason #1:

The current tax treatment aligns with economic realities; the rules aren’t merely a “giveaway” or “loophole” for life insurance. For example, the death benefit payment is, by construction, compensation for a loss. If you get into a car accident, the check from your auto insurance company to repair your vehicle’s damage isn’t treated the same as if your boss gave you a Christmas bonus at work. No, the auto insurance claim compensates you for damage; it’s not net income. Likewise, when you take out a policy loan against your policy’s underlying Cash Surrender Value, that’s not income. It’s a loan. Hence, it makes economic sense that the IRS doesn’t (if you have handled your policy correctly) tax it as income.

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Reason #2:

The more people who open up Whole Life insurance policies under the existing regulatory and tax framework, the bigger the constituency who will oppose changes. This is why it has proved difficult (though not impossible) to tinker with the favorable tax treatment of employer-provided health insurance and interest on home mortgages. For a different example, apparently, Franklin Roosevelt deliberately made Social Security available to all seniors — rather than making it a minor program only for those with inadequate retirement savings — in order to make it impossible for a future politician to repeal.

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Reason #3:

Even if Congress changes the tax treatment of Whole Life insurance down the road, there is ample historical precedent for the new rules to apply only to policies issued after the rule change. In other words, previously issued policies may be grandfathered in with their original treatment. This was the case for older mortgages when the deductibility rules changed, and it occurred in the life insurance sector back when there were significant tax treatment changes in the late 1980s.

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For the above reasons, fear of future rule changes should make one feel free to consider obtaining one or more Whole Life policies. Interested readers should check out infineo’s website for more details and to talk to someone about their specific circumstances.

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NOTE: This article was released 24 hours earlier on the IBC Infinite Banking Users Group on Facebook.

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Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together Whole Life insurance policies and digital blockchain-based issuance.