Permanent Life Insurance: What It Is and Why a New Law Has Made It Better

Perhaps no wealth planning tool considered by most dermatologists is as strongly debated as permanent life insurance. On the one hand, permanent life insurance plays a major planning role for many individuals and businesses—from successful physicians, attorneys, and corporate executives to the country’s wealthiest families, leading banks, and Fortune 1000 companies. On the other hand, innumerable commentators and advisors in the media deride permanent insurance as a poor investment.

In this first of a two-part series, we explain what permanent insurance is and how a federal statute passed in the last days of 2020 may have made it better. In the next article, we will cover why many dermatologists use it, who should avoid it, and key success factors in utilizing it properly.

What Is Permanent Life Insurance?

Before we explain what permanent insurance is and is not, let’s examine the alternative life insurance offering: Term insurance policies that offer pure death benefit protection. They carry no cash value and provide protection for a limited period of time (referred to as a term). This limited time frame is usually 10 to 20 years, though some companies offer a 30-year term product. A term life insurance policy pays a specific lump sum to your designated beneficiary upon your death, so it can play an important role in providing temporary death protection for your family (or your practice or partners as part of a buy-sell arrangement).

The category of permanent life insurance comprises products that, unlike term, carry cash values along with death benefits and can last for the entirety of the insured’s life—to age 100 or beyond. (Of course, these products are “permanent” only as long as the required premiums are paid on time.)

While there are several different products in the general category of permanent insurance, all permanent policies enjoy tax-free growth of cash value and, if properly managed, access to the cash value tax-free. These tax benefits, along with asset protection in many states, is what attracts many dermatologists to permanent insurance.

While there are more than five major categories of permanent life insurance, we only have room here to describe two. For more depth on this topic, see the “Special Offers” at the end of this article to request or download our free book.

1. Whole Life Insurance

Whole life insurance (WL) pays a death benefit to the beneficiary you name and offers you a cash value account with tax-deferred cash accumulation.

Pros: WL has a savings element (cash value) that is tax deferred. The cash value grows based on the life insurance company paying a dividend. This dividend is determined by the life insurance company, is not guaranteed, and is likely to change annually. Because of the low-interest-rate environment over the last fifteen years, dividend rates on whole life policies have been decreasing. You can borrow from this account free of income tax, or, if it is properly structured, you can cash in the policy during your lifetime. It has a fixed premium that can’t increase during your lifetime (as long as you pay the planned amount), and your premium is invested long term. Because it has the cash accumulation component, whole life insurance can offer benefits such as tax reduction, wealth accumulation, asset protection, estate planning, and tax diversification of asset classes.

Cons: WL does not allow you to invest in separate accounts (e.g., money market, stock, and bond funds). Thus, your policy’s returns will be tied to the life insurance company’s dividend credit based on that insurance company’s underlying investments. It also does not allow you to split your money among different accounts or to move your money between accounts, and it does not allow premium flexibility or face amount (the death benefit amount) flexibility.

2. Equity-Indexed Universal Life Insurance

Equity-indexed universal life insurance (EIUL) is a universal life policy (with more premium and policy flexibility than a WL) that allows you to select from a list of stock market indices to grow your cash value. If investments fail, a guaranteed minimum benefit is paid to your beneficiary upon your death.

EIUL offers more upside than a traditional universal life policy because the insurance company contractually agrees to credit the policy’s cash value with the same return as the stock market index the policy holder chooses (typically, the S&P 500 Index, but it can be the Dow, NASDAQ, or others) realized over the same period of time, subject to a cap and a floor. Thus, the policy owner has the upside of the indices (up to the cap) but the risk of the same indices (but only to the floor). Typical floors for an annual return begin at near 0 percent (no loss of principal), with caps around 10 percent.

Pros: EIUL offers potentially more upside in cash value accounts than WL but also gives you downside protection.

Cons: Products are relatively complex, with many choices of indices, participation rates, floors, and caps, and they vary significantly from insurance carrier to carrier. Working with a professional who can help you make decisions about policy placement and annual management is essential.

A “Good” Investment?

When thinking about permanent life insurance, many dermatologists ask whether it is a “good” or “bad” investment. However, this question rests on a faulty assumption: How can permanent life insurance be a “good” or “bad” investment when the choices within permanent products are so broad and deep? In other words, the structure of a permanent life insurance policy allows for an almost limitless number of underlying investments within the structure—and those investments will provide the policy’s returns.

WL offers a bond-based, dividends-type return. Is this good or bad? It depends on what the rest of the market does. In 2008–09, an asset with such a return would likely have been the best-performing asset class on a physician’s balance sheet. For EIUL, the performance of the policy is based on the owner’s choice of indices—which could work out extremely well…or not.

A permanent life policy can be a fantastic, great, good, fair, or poor investment because it isn’t an investment. It houses investments, the choices of which are almost innumerable.

Changes from New Law Passed in 2020

In the last week of 2020, the Consolidated Appropriations Act, 2021 was adopted. This included revisions to tax code Section 7702—which covers what the federal government considers to be a legitimate life insurance contract and impacts the pricing, structuring, and taxation of permanent life insurance.

Suffice it say the new law will make permanent life insurance policies more attractive, by allowing policyholders to have more funds grow tax-free than have been allowed under recent rules. Thus, for dermatologists attracted to this asset class for its tax-free growth and access, the new statute is a welcome one. Expect to hear more about this, as insurance companies restructure their products in response to the new law.

Permanent insurance, while often misunderstood, has significant tax benefits, which have only been improved by new law. In part two, we will discuss why many use permanent policies, who should avoid them, and key success factors.

OFFERS: The authors recently completed Wealth Planning for the Modern Physician, their first book for physicians in five years. To receive free copies or ebook downloads of this or Wealth Management Made Simple, text PRDERM to 47177, or visit ojmbookstore.com and enter 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.