PracticalDermatology

In the first installment of a two-part article (which you can read here), we explained what permanent life insurance is and how a federal statute passed in the last days of 2020 may have made it better. In this article, we will cover why many dermatologists use it, who should avoid it, and key success factors in utilizing it properly.

Why Dermatologists Use Permanent Policies

The three leading reasons to use permanent insurance are wealth accumulation, asset protection, and estate planning.

1. Wealth Accumulation

Because of the varied investment options within permanent life insurance, the tax-free growth of cash values, and the ability to access such values in retirement (or whenever you want) tax-free, permanent insurance can be a powerful part of your wealth accumulation/retirement plan. Further, when compared to qualified retirement plans, with their income taxation upon withdrawal, and most after-tax assets’ creation of capital gains taxes upon liquidation, the tax-free access to cash values in a permanent life policy provides extremely valuable tax diversification in a long-term retirement plan.

2. Asset Protection

As we have discussed in prior columns, asset protection planning is an important area of wealth management for many dermatologists. In many states, in fact, permanent life insurance is a (+5) exempt asset—providing the highest possible level of protection. Further, many states give unlimited protection to both cash values and death benefits, making permanent insurance policies a significant part of many physicians’ asset protection planning.

3. Estate Planning

The tactics that involve using permanent life insurance in estate planning are many and varied. For our purposes here, it is important to understand that permanent life insurance plays an important role in estate planning because it is permanent (as long as premiums are paid) and because of the liquidity it provides upon the death of the insured (a single person or the second to die of a married couple). The proceeds generally are paid income-tax-free and, within a properly implemented trust, can pay out estate-tax-free as well.

Term insurance cannot play the same role because it is never guaranteed to last until death.

Not All Dermatologists Should Own Permanent Life Insurance

Despite the benefits of permanent life insurance, it is not appropriate for all physicians. For many, simple term insurance products are all that is needed. In fact, if all of the following are true for you, term insurance may well be your best option:

1. Tax-free Growth and Access Are Not Important.

You may not need permanent life insurance if you are in one of the lower income tax brackets or otherwise pay little or no income tax or capital gains tax on investments because of other deductions or losses that will be applied against income or gains for the foreseeable future.

2. Asset Protection Is Not a Planning Goal

If you are not concerned about potential liability or you live in a state that does not protect life insurance cash values, you may not get as much benefit from permanent life insurance.

3. Asset Diversification Is Not a Priority

The cash value within a life insurance policy can grow in a variety of ways: as part of a fixed-income portfolio managed by the insurance company, through a mutual fund-based approach, or as part of a market-based strategy with downside protection featuring a floor that the insurance company guarantees the rate of return will not go below. You may not need permanent life insurance if you are satisfied with the diversification of your investments and any use of guaranteed asset classes in your portfolio.

4. State or Federal Estate Taxes Do Not Impact Your Planning

If your projected net worth is under both your state’s and the federal estate tax exemption amount, or you have no children or grandchildren, you may not need permanent life insurance as an estate planning tool. Of course, tax laws change often, so it is difficult to say for certain that they will not affect your planning decades from today.

Four Success Factors in Using Permanent Life Insurance

If you consider using this asset class as part of your planning, here are four fundamental success factors to consider:

1. Long-Term Time Horizon

Whether a permanent life policy is designed to accumulate significant cash values for the policy owner’s retirement or for any other purpose, it is important that the physician have a relatively long (15 years or more) time horizon.

One reason that a long time horizon is important relates to the fact that, in many permanent insurance products, many of the policy expenses are front-loaded. In fact, nearly all life policies have a “surrender charge” that is imposed if you surrender the policy in full (but, importantly, not if you access some of the cash value). The amount of this surrender charge covers many of the insurance company’s upfront expenses (including the agent commission), and it decreases over time. The surrender charge in many policies hits zero between eight and 15 years. If you keep the policy in force beyond the surrender period, you have effectively amortized the upfront costs over time and will not be penalized if you surrender the policy.

Taxes are another important reason to keep these policies in place for a long time. This is especially true for people using them for future retirement income because the tax benefits afforded by a policy (tax-free growth within the policy and tax-free access through basis withdrawals and policy loans) gain value as the policy growth compounds over time. As with a Roth IRA, simple math dictates that the longer one can enjoy tax-free growth and access, the better.

2. A Design for Flexibility Up Front

Given the long-term nature of permanent insurance, things may change over time—for the owner, for the investments within the policy, with tax laws, and with insurance carriers. Best practices for an insurance advisor, therefore, call for designing a flexible policy. Flexibility can be built into the policy in several ways, including permitting changing investments within the policy, paying more or less premium, changing premium frequency, adjusting the death benefit, and adding or removing a beneficiary. The more flexibility the policy is designed to allow, the more options the owner has to adjust how it works in their plan as circumstances change over time.

3. Regular Reviews and Maintenance

In this way, permanent life insurance is like any other asset class in which you might invest: regular performance reviews are necessary. Whether it means changing investments within the policy, paying more or less premium, changing premium frequency, adjusting the death benefit, adding or removing a beneficiary, or even exchanging the policy for a different type, regular reviews are when the agent and policyowner bring issues to light and make decisions accordingly. Permanent life insurance is not a set-it-and-forget-it asset—few valuable assets are.

4. A Sophisticated and Ethical Insurance Agent

The most important of the four success factors may be working with an ethical insurance agent who understands the plethora of products in the market as well as the details of the specific policy you might use. If you work with such an agent, they will make sure that the other three factors are in place. If you do not, the absence of any of the success factors could undermine the policy’s performance and the value of this asset class in your overall planning.

Conclusion

Permanent life insurance has several attributes that make it attractive for many dermatologists for wealth accumulation, asset protection, and estate planning purposes. Awareness of a few key success factors, however, is essential to properly leveraging and maximizing the value of this asset.

The authors have recently completed Wealth Planning for the Modern Physician. To receive free print copies or ebook downloads of this book or Wealth Management Made Simple, text PRDERM to 844-418-1212, or visit www.ojmbookstore.com and enter promotional code PRDERM at checkout.

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This article contains general information that is not suitable for everyone. Information obtained from third party sources are believed to be reliable but not guaranteed. OJM makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.