Insurance

Risks vs. Benefits of Life Insurance Loans

Estate Planning, Insurance, Personal Finance / By

Because of the economic downturn triggered by the COVID-19 crisis, many people have found themselves in need of cash to pay unexpected medical bills, mortgage payments and other expenses. One option is to borrow against the cash value of a permanent life insurance policy, but such loans aren’t risk-free.

Recognizing Potential Pitfalls

Before you borrow against a life insurance policy, consider risks such as:

  • Reduced benefits for heirs
    If you die before repaying the loan or choose not to repay it, the loan balance plus any accrued interest will reduce the benefits payable to your heirs. This can be a hardship for family members if they’re counting on the insurance proceeds to replace your income or to pay estate taxes or other expenses.
  • Possible financial and tax consequences
    Depending on your repayment schedule, there’s a risk that the loan balance plus accrued interest will grow beyond your policy’s cash value. This may cause your policy to lapse, which can trigger unfavorable tax consequences and deprive your family of the policy’s death benefit.
  • Eligibility
    You can borrow against a life insurance policy only if you’ve built up enough cash value. This can take many years, so don’t count on a relatively new policy as a funding source.

Tapping Cash Value

There can be advantages to borrowing from a life insurance policy over a traditional loan. These include:

  • Lower costs
    Interest rates are usually lower than those available from banks and credit card companies, and there are little or no fees or closing costs.
  • Simplicity and speed
    So long as your insurer offers loans, there’s no approval process, lengthy application, credit check or income verification. Generally, you can obtain the funds within five to 10 business days.
  • Flexibility
    Most insurers don’t impose restrictions on use of the funds. And you have the flexibility to design your own repayment schedule. You can even choose not to repay the loan, though that has negative tax consequences.
  • Generally no tax impact (as long as policy doesn’t lapse) 
    Funds acquired by borrowing from a policy aren’t considered income, so they’re typically not reported to the IRS. This differs significantly from surrendering a policy in exchange for its cash value, which triggers taxable gains to the extent the cash value exceeds your investment in the policy (generally, premiums paid less any dividends or withdrawals). Note that interest paid on the loan typically isn’t deductible.

Reviewing Your Options

Be sure you really need to borrow from a life insurance policy before doing so. Consider alternatives, such as selling an asset or reducing expenses. We can help you make the right choice.

Dispelling a Myth

There’s a common misconception that, when you borrow against a life insurance policy, you’re “borrowing from yourself.” In other words, when you pay interest on the loan, you’re essentially paying yourself.

This may be true when you borrow money from a retirement plan, but it’s not accurate when it comes to life insurance policy loans. In fact, you’re borrowing from your insurer, pledging the cash value of your policy as collateral and paying interest to the company. Policy loans may be cheaper than traditional loans, but they’re not free.

Seniors: Medicare Premiums Could Lower Your Tax Bill

Insurance, Medical Expenses, Personal Finance, Retirement, Taxes / By

Americans who are 65 and older qualify for basic Medicare insurance, but they may need to pay additional premiums to get the level of coverage they desire. The premiums can be expensive — especially if you’re married and both you and your spouse are paying them. One aspect of paying premiums might be a positive, however: If you’re eligible, they may help lower your tax bill.

Premium Tax Deductions

Premiums for Medicare health insurance can be combined with other qualifying health care expenses for purposes of possibly claiming an itemized deduction for medical expenses on your individual tax return. This includes amounts for “Medigap” insurance and Medicare Advantage plans.

Some people buy Medigap policies because Medicare Parts A and B don’t cover all their health care expenses. Coverage gaps include co-payments, co-insurance, deductibles and other costs. Medigap is private supplemental insurance that’s intended to cover some or all gaps.

Fewer Itemizers

Qualifying for a medical expense deduction can be difficult for a couple of reasons. For 2019, you can deduct medical expenses only if you itemize deductions and only to the extent that total qualifying expenses exceeded 7.5% of AGI.

The Tax Cuts and Jobs Act nearly doubled the standard deduction amounts for 2018 through 2025. For the 2019 tax year, the standard deduction amounts are $12,200 for single filers, $24,400 for married joint-filing couples and $18,350 for heads of households. So, fewer individuals are claiming itemized deductions. However, if you have significant medical expenses (including Medicare health insurance premiums), you may be able to itemize and collect some tax savings.

Important note: Self-employed people and shareholder-employees of S corporations can generally claim an above-the-line deduction for their health insurance premiums, including Medicare premiums. That means they don’t need to itemize to get the tax savings from their premiums.

Other Deductible Medical Expenses

In addition to Medicare premiums, you can deduct a variety of medical expenses, including those for ambulance services, dental treatment, dentures, eyeglasses and contacts, hospital services, lab tests, qualified long-term care services, prescription medicines, and others.

Keep in mind that many items that Medicare doesn’t cover can be written off for tax purposes, if you qualify. You can also deduct transportation expenses to get to medical appointments. If you go by car, you can deduct a flat 20-cents-per-mile rate for 2019.

More Information

Contact Maggart if you have additional questions about Medicare coverage options or claiming medical expense deductions on your personal tax return. Our team can help you identify an optimal overall tax-planning strategy based on your personal circumstances.