What Is an IGIC?
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An investment-grade insurance contract, or IGIC, is an insurance contract that allows you to both invest your money without having to pay taxes on its growth, but also use it when you need it without having to pay taxes on the money you use. That means you can put your money away, make interest, earn interest on your interest, and share very little, if anything with the government.
You can also leave it to your heirs without subjecting it to income tax. So no taxes while it is accumulating, no taxes while you are distributing it, and no income taxes when the death benefit gets passed to your heirs.
Those are not the only distinctions between IGICs and government-regulated vehicles like IRAs and 401(k)s. Unlike the more traditional retirement accounts, IGICs grow without any stock-market risk while still offering competitive growth. They don’t impose penalties for using the money (and you can choose whether to pay it back), and it comes with a death benefit beyond the cash value. And the death benefit is permanent and guaranteed. There is no term that expires after a certain number of years. It’s also tax free.
Another benefit is long-term care and chronic-care expenses. Because the death benefit is guaranteed, in some circumstances, you can access a part of the death benefit to pay for assisted living or long-term expenses while you’re still alive.
All these tax benefits are possible because this account is purchased with after-tax dollars. So instead of writing off your premium contributions like you would with an IRA or 401(k), you are going to lose the immediate but small tax advantage of a qualified account in exchange for large and long-term tax benefits.
In most cases, once your money goes into an IGIC, neither it, nor the growth, nor the death benefit, will ever be subject to taxes again. There are a few minor exceptions, which are discussed below.
Like any other life-insurance product, your overall health is a factor in qualifying, so not everyone will qualify. But then again, you can be the owner of the contract but not the insured, so you can still use this strategy if you have an insurable interest in someone who is insurable—like a spouse, child, or key employee.
Why Haven’t I Heard of an IGIC?
For a long time, life insurance was used almost exclusively for, well, insuring a life. It was designed to provide for the survivors by replacing the income of the deceased breadwinner.
With cash-value life insurance, the insured was not only buying a death benefit, but was also accumulating a cash reserve—something the insured could use while they were still alive, like an emergency fund or retirement account.
But because life insurance contracts have huge tax benefits over other more traditional investment vehicles, savvy investors started using it as a way to invest money, rather than just insuring a life.
Whereas a typical life insurance contract has most of the premium being paid to purchase to the death benefit and a smaller portion being put into the cash account, an investment-grade insurance contract does the same thing in reverse: it puts far more premium toward the cash value and very little towards the death benefit. That way, your money is being invested rather than just set aside for your heirs. But because it is still an insurance contract, it has the same tax protections as any other insurance contract.
So what exactly are those tax benefits?
To understand the advantages of an investment-grade insurance contract, let’s learn some simple terminology.
There are three stages of wealth accumulation: first is the accumulation stage, where you are earning money and putting it away into some investment vehicle. During the distribution stage, you are reaping what you’ve sown and able to pull money out of the investment vehicle. And finally, there is the wealth transfer stage, which is when you pass on what’s left of your accumulation to others.
During the accumulation stage of a typical retirement account, the government entices you to put your money away into a 401k, IRA, or other qualified account by offering to reduce your taxable income by the amounts you put into those accounts, and in exchange, the government won’t charge taxes on the amounts in the account until you take money out of the account at the distribution stage, which you have to do on the government’s terms. But what does that really mean?
The average American pays at a tax rate of about 12.5%. So for the average American, what the government is really offering is this:
- For every $1,000 you put into a qualified account, you will save $125 in taxes for that year.
- But, there are limits to what you can contribute (up to $6,000 max per year for IRAs and $19,000 for 401ks in 2019).
- The money you put away in these accounts will be invested and will presumably grow.
- But, you bear all the risk associated with the investment. If the economy tanks, and the value of your account gets cut in half, those are 100% your losses.
- Then, when you’re 59 ½, you can begin taking the money out, at which time you’ll pay taxes on the money as ordinary income.
- But, if you withdraw any of the money before you’re 59½, you’ll pay a stiff penalty (10%) plus taxes on the withdrawal.
- Plus, you pay taxes on the complete withdrawal, including the principal you invested and all the earnings.
- If you want to keep the money in the account past 59½, to maximize the growth, you can.
- But, at age 72, you have to start taking money out of the account whether you want to or not, and at that point, it counts as income and is fully taxed.
- If you die while there is still money in the account, then the account gets passed on to your heirs.
- But, that amount is included in your taxable estate and the heirs will have to pay income tax on any money withdrawn from the account.
Now let’s consider how investment-grade insurance contracts work in a similar scenario:
IGIC Accumulation Stage
With an investment-grade insurance contract, you pay taxes first. Then you pay your premiums. That means for every $1,000 the average American puts into the insurance contract, they will have already paid $125 in taxes. And with few exceptions, those are the only taxes they or their heirs will ever have to pay related to this account.
Unlike a qualified account, you are not limited to $6,000 or $18,000 per year in contributions. As long as there is an insurable interest, the sky’s the limit.
And whereas a qualified account comes with huge economic risk, insurance contracts are guaranteed against loss. No matter how poorly the economy is doing, you’ll have a guaranteed minimum return on your investment plus non-guaranteed dividends (together, usually around 4–5% average per year over the life of the contract).
IGIC Distribution Stage
Whereas the distribution stage of a qualified account does not begin until age 59½ (without incurring steep penalties), and must occur by age 72, the distribution stage of an insurance contract is infinitely flexible.
At any time—starting from the day after you make your first premium payment up until your death—you can use the cash value of your account. That’s any time, for any purpose, in any amount (up to about 90% of the accumulated cash value, which includes principal, interest, and dividends). No early-withdrawal penalties. No required minimum distributions. Nothing but freedom and flexibility.
You can use the cash value either by withdrawing it directly from the account (which is not recommended, because you’ll lose interest-earning potential and trigger a taxable event once you withdraw past your basis, or contributions), or you can use the cash value as collateral for a low-interest loan, (which we highly recommend because if you do it right, the cash-value of your account will always earn more interest than what accrues with the loan, and you’ll also never pay taxes on it).
These loans are always tax free, and the withdrawals of the cash value are tax free up to your cost basis (the amount you’ve paid in premiums over the life of the policy). Dividends are also tax free except to the extent they exceed your cost basis.
IGIC Transfer Stage
By the time you retire and are living off of the wealth accumulated over the accumulation stage, you are probably going to be very grateful you put your money into an insurance contract instead of a qualified account. And despite all the advantages we have covered so far, it’s during the transfer stage that the insurance contract really shines.
Both the qualified accounts and the insurance contract have accounts with cash value that have accumulated over time. But the insurance contract comes with much more, including a death benefit. A death benefit that will always exceed (usually far exceed) the amount you’ve paid into the account.
If you just have qualified accounts, when you die, the leftover money in your accounts will be passed to your heirs, and they’ll pay taxes on it as ordinary income when they distribute against it (which they have to do within 10 years under the new rules). But with an insurance contract, when you die there are two accounts to consider: the first is the cash account. That is the account that you’ve been living off of to fund your retirement (by taking out loans against the policy). This account is for you, not for your heirs.
The second is the death benefit, which is always going to be greater (usually much greater) than the cash value. When you die, your death benefit first goes to pay off any loans you’ve taken against the cash value. Then the rest is passed to your heirs completely tax free. They won’t have to pay any income tax on those funds. And as long as your estate, with the life insurance, is not worth more than $11.7 million (as of early 2021), your estate won’t owe any estate taxes, either.
How Do I Go About Setting Up an Investment Grade Insurance Contract?
Give us a call!
Typically with life insurance, the agent will first determine how much life insurance you need. The agent will undertake an analysis that includes how much your heirs depend on your income, and how much they would need in a lump-sum to replace your income. The cash-value of the account will be an afterthought.
Done this way, the insurance agent gets much bigger commissions as most of the commissions are calculated from the policy premiums paid toward the death benefit.
With an investment-grade insurance contract, though, we instead start with how much money you want to/can afford to put away every month. Then, using the IRS’s algorithm for insurance contracts, we write the contract with close to the minimum amount of death-benefit-to-cash-value ratio allowed. That way, most of your money goes to you. Fees and commissions are minimized, and because it’s still an insurance contract, you still get all the benefits discussed above.
There are many different ways to set up an investment-grade insurance contract, including all of the benefits you can ordinarily purchase with life insurance, including long-term care, early access to the death benefit for terminal illness, accidental death riders, early paid up additions, and much much more.
The Fortune Law Firm can help you get your plan properly structured.
*Note: The Investment-Grade Insurance Contract IS NOT an investment. Life insurance contracts like these are never investments. They ARE, however, tax-advantaged vehicles through which you can experience tax-free growth and generate a death benefit and living benefits.
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