Reducing income taxes both now and in the future requires planning. Home ownership, participation and maximization of employer sponsored retirement plans (i.e. 401(k)), charitable deductions are all good ideas. However, what if you're already taking advantage of these tax reduction strategies? Consider the use of whole life insurance as a vehicle to not only protect your family, but reduce income taxes both now and in the future.

Current Tax Treatment of Whole Life Insurance
Whole life contracts enjoy many tax benefits. Many years ago, Congress saw life insurance as a means to take pressure off of the Federal Government to provide financial benefits to loved ones who suffer a loss of life. They felt, and still feel today, that life insurance is a product that contributes to the common good of society and therefore continue to grant whole life insurance tax benefits to entice Americans to acquire the product.

Most know that life insurance proceeds are paid to beneficiaries income tax-free. This is a tremendous tax benefit. Some are aware that the internal grow of cash values that accumulate inside life policies accumulate tax deferred. Meaning, that no tax is due on the gain (i.e. interest, dividends) until withdrawn from the policy. However, what most don't know is that life insurance enjoys the FIFO (first in - first out) accounting method. This accounting allows the distribution of cash values, if structured properly to be paid to the owner of the policy income TAX FREE!

Tax Deferred Accumulation
Life Insurance is not an IRA, not a Qualified Plan, and doesn't have restrictions on when or why the owner can withdrawal cash values. However, those cash values enjoy tax deferred growth. This presents a significant tax savings opportunity. If saving for anything on an intermediate or long-term basis, and those assets are currently being taxed via IRC section 1099, then it is possible that you can deposit/transfer those assets into a whole life insurance policy and shelter them from taxation. Most commonly, I see professionals, executives & small business owners who are maximizing their retirement plans contribute additional discretionary income into whole life policies to take advantage of the tax deferred growth.

Tax Free Distributions
Because of the FIFO accounting, the first money distributed from insurance policies is the first money that went in....the premium which was paid on an after tax basis. Because taxes were already paid on the premium, these assets come out first tax-free. Anything withdrawn beyond the premium paid, or cost basis, will be taxed as ordinary income. However, loans from life insurance are tax-free. The typical design of a successful distribution strategy from a whole life contract would be to withdrawal the basis first, then loan the remainder to the policy owner. In essence, this strategy allows for the distribution of the cash value on a completely tax-free basis.

Be Careful
The only issue owners need to be careful about with this strategy is that if they must keep the policy in-force until the insured dies. This means that all the cash value can't be distributed from the policy. Most of the insurance company's illustration systems can calculate distribution models so lapse of the policy will not occur given a set of assumptions.

Whole life insurance is an incredible financial asset. Not only does it protect the family on a tax favored basis, but when properly designed, can be a significant vehicle to shelter assets from taxation.