Whole life insurance is a permanent life insurance policies that offers death benefit protection, cash value accumulation, tax-deferred growth, and tax-free withdrawals.
The use of a whole life insurance policy is necessary within the Restricted Property Trust. The use of whole life insurance is what allows the business owner to recognize the deduction. When contributions are made to the Restricted Property Trust the trustee makes a payment to the whole life insurance company.
In the Restricted Property Trust the participant receives a death benefit. The death benefit amount is determined based on the desired contribution. By doing this we are minimizing the amount of death benefit coverage in order to maximize the growth of the cash value.
When premium is received the cash value of the policy grows based on a credited dividend rate issued by the whole life insurance company. The cash value of a whole life insurance policy is very conservative and similar to a CD or Corporate Bond. There is no market risk in a whole life insurance policy. The growth of the cash value is not taxable on an annual basis.
After the participant has completed funding the Restricted Property Trust the ownership of the policy is transferred from the trust to the individaul participant. When ownership of the policy has been transferred the participant will take a withdrawal from the policy to pay the taxes owed on the transfer of ownership.
After the participant takes the withdrawal from the policy, the death benefit is reduced as much as possible to avoid any additional premiums being required. We refer to this as step as having a Reduced Paid-Up (RPU) policy.
At this point, the insured has a fully paid-up life insurance policy.
By reducing the death benefit it allows the cash value of the policy to grow more rapidly. The reason for this is by reducing the death benefit we have less mortality and administrative costs. As the cash value grows so to will the death benefit.
Once the policy is transferred from the Restricted Property Trust the participant can access the cash value of the policy at any time in the form of a tax-free withdrawal or policy loan. As distributions are made from the policy the death benefit is reduced by a like amount. This can help the participant maximize retirement income.
It is important that the policy stays in force for the life of the insured. Any surrender of the policy or lapse in coverage will require the owner to pay ordinary income taxes on any amount in excess of the policy cost basis.
Still confused about how it all works? We’re happy to help. Feel free to contact us any time for a consultation.