Income Tax For Life Insurance Annuities And Hybrid Long Term Care

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It's about to start in just a few seconds. Enjoy it, and please share it around with all your friends. Thanks for listening, and thanks for choosing the Truth Podcast Network. This is the Truth Network. Welcome to Finishing Wealth, brought to you by cardinalguide.com, with certified financial planner, Hans Scheil, best-selling author and financial planner, helping families finish well for over 40 years. On Finishing Wealth, we'll examine both biblical and practical knowledge to assist families in finishing wealth, including discussions on managing social security, Medicare, IRAs, long-term care, life insurance, investments, and taxes. Now, let's get started with Finishing Wealth. Oh, welcome to Finishing Wealth, with certified financial planners, Hans Scheil and Tom Griffith, and today's show, Oh, You're Gonna Love This If You Love God. I can just tell you, even though at first you might go, what?

I'm going to tell you, it's perfect. Income tax for life insurance annuities and hybrid long-term care is actually the title of the show, but let me tell you why I know that this is really, really important to God's heart. The reason I know that is because in James, the book of James, Jesus' brother wrote this, and he was pretty clear on it. He said, pure religion, undefiled before God and the Father is this.

Now, wouldn't you like to know what this is? Well, it's to visit the fatherless and widows in their affliction and to keep himself unspotted from the world. You can see, and again, God tells us over and over and over again to be mindful of the widows and orphans, but of all the widows and orphans you should be mindful of is yours, right? You realize at the point in time that you require long-term care, your kids are becoming fatherless, but the point in time that you pass away, your wife is becoming a widow or your kids are becoming orphans.

And even if that happens, because I've had it happen now to me with both my parents, if that happens at 60 or 70, it still has a huge impact on their life. And so the ramifications and why some of the tax benefits are on these things we're going to talk about today is because this is right in God's wheelhouse. He really, really cares about your widow. He really, really, really cares about your orphans. And so, you know, yes, this has to do with visiting widows and orphans and other places, but it also has to do with doing some planning around your future widows and orphans because it is going to happen to us and it's an honor actually to put God in on that and begin to do some planning, but to do that, we've talked about before, requires humility and asking God what he thinks and then getting assistance from godly people. So with that, Hans?

Well, yeah. So today's show is really to give you some clarity about how annuities are taxed and how life insurance is taxed and how this hybrid life long-term care or hybrid annuity long-term care insurance, how it's taxed. And there's a lot of benefits that the government has put into this, put into these insurance products.

And I think we opened the show or opened the preparation for the show of like why. And so, Tom, why does the government put these tax advantages into insurance products? Yeah. I mean, I think this along with most of the tax code is there to incentivize the population to take action to do something and encourage them to invest or put money in some of these things. So let's take life insurance as an example. Life insurance pays a tax-free benefit to the beneficiary. So if we have a couple and the husband and wife and the husband buys life insurance on his life and then he dies, his wife gets money right away that's tax-free. So they don't have to worry about taxes. They get to keep it and they get to use it to help support themselves.

I mean, so really the tax code and the tax benefits of all these products are there to incentivize people to do something about these different areas. Yeah. And what I would add is the government's really not in the business of taxing or extra taxing widows like they got a windfall. If you sat here and you thought about it is if you're inheriting from your father or mother $200,000 and you receive it from an IRA and you compare that to receiving $200,000 from a life insurance policy, can you compare those two things for me?

Yeah. I mean the IRA, every dollar that if it's a traditional IRA is taxable. So if you pulled that out in a single year, you're going to be paying 40% in taxes on that. You don't get to keep all that 200. A life insurance policy, all of that is tax-free. You get to keep every last penny of that 200,000. But we've had people come in who've been beneficiaries of life insurance policies. We kind of get the check, they get the check and they're sort of concerned like, well, how much do I owe on this? How much taxes do I owe on this?

And it's hard to believe when they're getting it. It's like you don't owe any. This is just tax-free, cash it and then just go on.

Well, yeah. And so we're going to get into like specifically how does the tax system work on annuities? How does it work on life insurance? And how does it work on the hybrid life long-term care?

We're going to give you the facts, but I want to stay on this for a minute. When you get to annuities, I mean, annuities have a clear tax advantage that we utilize for people all the time. I mean, you could put $100,000 into a multi-year guaranteed annuity, let's just say for five years. And you were able to get 5% interest on that. You can actually get a little bit more than that now, but let's just say 5% interest. So that's $5,000 you make in the first year on the $100,000 you put in this annuity. And that is going to remain untaxed until you draw it out. So the next year, you earn another $5,000 plus your interest on the $5,000 from the first year.

And that compounds and compounds for five years. And by the time five years is up, you got about $130,000 in this annuity, $100,000, which isn't going to be taxed ever because it's already been taxed. But $30,000 of it, you've postponed taxes on. And so when you compare that to a CD where you're paying taxes every year, possibly at a lower rate, why does the government do that? Well, the government, this annuity has the capability to turn into a payments for life system. And they want individuals, they want to encourage people to save for retirement because they know Social Security by itself is not enough.

It says it right on the brochure. And they, the government wants to encourage this so that people that are savers, they can put it into tax deferred items, and they can postpone the taxation. And on that example I gave at the end of five years, you don't have to all of a sudden pay the tax on $30,000 all at once. You can roll that into another multi-year guaranteed annuity or some other type of annuity and just further postpone it.

And it's not until you begin to make withdrawals that that money is going to get taxed. So, you know, with life insurance, you can avoid the taxation on the growth of it, even if you withdraw it yourself or you use the money in advance of you dying, you use the cash value. So as an example, let's say you bought a life insurance policy and you were paying a premium of $2,000 a year. And it was a cash value life insurance.

It didn't have a huge face amount. Most of the money was going in the cash value. Let's just say it was $100,000. And so you pay that premium for several years, let's say 10 years, and so you've put in $20,000 in the policy. Well, for starters, you could withdraw any of the $20,000 that you put in tax-free at any time, not paying any taxes on it.

So you can get your principal back. And it's principal first, interest second. You can borrow the principal or the accumulated interest because like 10 years later, you're going to have your $20,000 that you paid in in premiums. Plus, you're going to have some interest, some significant interest in dividends that have built up on that. And so let's just say that it's $27,000 or $30,000 that you've built up a balance. So you've got some interest there that is going to get taxed if you just pull it out and spend it.

But if you borrow it selectively, you could never pay tax on that earnings. It's just a little complicated for this show, but it's just, it's going to be paid for out of the tax-free death benefit or the loan gets paid back if you never make payments on it when you pass away. So life insurance, annuities, and then this hybrid life and long-term care insurance, it has several tax advantages. And I just want to be clear to people why the government put these things in there is because they want to encourage you to participate in these things. Because ultimately, they're going to pay a benefit to you or to your heirs exactly when it's needed. Right. And I can't help but think that God allows that, right?

Or clearly got that through Congress or whatever, because he's all behind this, right? That these are really, really good strategies when put together with people that know what they're doing to take care of your widow and your orphans, because that's what we got coming if you've got kids. So Tom, talk a little bit about this hybrid life long-term care. What are the tax advantages that are built into that?

Yeah. So I think just to define it, a hybrid long-term care policy is a combination of either a life insurance or an annuity that includes long-term care coverage that will help pay if you are no longer able to take care of yourself. And the benefit, there's several, if it's built on a life insurance chassis, so it's built on a life insurance policy, it has the same benefits as the other life insurance that we just talked about where the death benefit is tax-free.

You could potentially take loans out of it. You really wouldn't want to on a hybrid policy. But the biggest benefit are the long-term care benefits that pays out are tax-free. It's right in the tax code that benefits paid out of a long-term care policy are not considered taxable income to you. Again, really trying to incentivize you to plan for this.

Long-term care is a big expenditure that all these states have faced via Medicaid, the Medicaid system. And so they want to encourage people to plan for this and not have to worry about the tax implications of doing so. When it's built using an annuity, this is even maybe potentially even better from if you have, and I'll get into a second, but if you have an annuity, similarly, those benefits, those long-term care benefits are tax-free. Let's go through an example where someone purchased a non-qualified annuity that's with not IRA money.

We'll get back to that in a second. So it's not IRA money. They purchased annuity years ago, and it has these gains that have been deferred. So they've put off the gains, which has been helpful, but now eventually when they pull money out in a normal annuity, those gains would be taxable in the year they pull them out.

If it's in one of these hybrid long-term care annuities, the interest coming out to pay for long-term care benefits is not taxable. So we want to remind you that this show is brought to you by CardinalGuide, cardinalguide.com, and there you're going to find a seven worries tab. And today's worry is taxes, and so there there's a wonderful YouTube video on just this whole idea of income tax, life insurance, annuities, and the hybrid long-term care, as well as the show notes with all sorts of details on what these guys have been talking about today. And then, of course, there's a way to contact Hans to contact Tom and his book, Hans's book, The Complete Cardinal Guide to Planning for and Living in Retirement. It's all there at cardinalguide.com.

And so we'll be right back with so much more finishing well. Investment Advisory Services offered through Brookstone Capital Management LLC, abbreviated BCM, a registered investment advisor. BCM and Cardinal Advisors are independent of each other. Insurance products and services are not offered through BCM, but are offered and sold through individually licensed and appointed agents. Cardinal Advisors is not affiliated with or endorsed by the Social Security Administration or any other government agency. Well, welcome back to Finishing Well with certified financial planner, Hans Scheil, and today's show we're talking about income tax on life insurance, annuities, and hybrid long-term care, and how these are really beneficial products when it comes to tax strategies.

And take it away, Hans. Okay, so we want to talk about annuities first, and what Tom finished up with there, I'm wondering if you caught that. If you have an annuity now that you've had for several years, let's just do an example. You put $100,000 in there, and it's been sitting there for 10 years, and it's accumulated quite nicely, and you've got $160,000 built up in the thing. Okay, so you got $100,000 that you put in. This is not an IRA.

This is just regular money. You've already paid tax on the money deposited, but there's $60,000 of interest that somebody is going to pay taxes on. Either you, when you start drawing it out, or your heirs, your children, your adult children, or your spouse, or whoever's the beneficiary. When they inherit that annuity, they're going to inherit the tax liability on the $60,000 right along with it, or more, because you're not going to die right away. So, and if you've been considering these hybrid long-term care insurance policies, and you've been wondering, like, how am I going to pay for that? You could use this annuity, roll over the whole $160,000 or the whole amount of the annuity from where it is into one of these hybrids, and then let it keep growing, and let it also keep paying a premium on an annuity extension rider, because you're going to need more than $160,000 of annuity, excuse me, of long-term care benefits. And so, effectively, if you use it for long-term care, and it pays out that interest, then nobody's ever going to pay tax. You're not going to pay tax on it, because it's coming out as a long-term care benefit, and your heirs are not going to pay taxes on it, because it's already been spent on long-term care. So that's a, that's a pretty sweet function of the thing, and it's done with interest first.

So what I want to do with the rest of the show is just really talk about these three things, and what are the nuts and bolts of the taxation. So we're going to start with annuities, and what I want to do is exclude the IRAs, because we take a lot of IRA money, and we put a client's part of their money into an annuity. So you can do that, is you can, we can take IRA or 401k money that hasn't been taxed, and move it without paying taxes into an annuity that's going to pay a future income, okay? And the point I want to make is the taxation of that is going to be just like an IRA, is any money coming out of there is going to be taxable, either to you or your heirs when they receive it.

But that's not what we're talking about on this show. We're talking about where you buy an annuity and you are taking money you already paid taxes on, just money in the bank, money in an investment account where you've already paid the taxes, and you put it into an annuity presumably so it's going to grow and possibly create a future income for you. But many people never take the income piece of that. They just, they move their money into an annuity for the tax and the growth, the tax deferral. So they understand, I'm going to have to pay taxes on that interest, accumulated interest sooner or later, I just don't want to pay it now. And so that's how an annuity, it's tax deferred. There's no 1099s on the internal growth and when you start pulling money out of the thing, you're going to pay the taxes then. So you can do that scientifically, selectively, you can do it in a series of payments over your life, but it's going to get taxed when it's coming out of the thing, okay? And it's going to be interest first, principal second. Do you want to just take it from there, Tom, and talk about the taxation of annuities?

Sure. I mean, I think the, it's very dependent upon the type of annuity too. So, you know, if you have some questions, call us because it can get somewhat complicated, but there is a way to set it up where the taxes owed on the annuity is spread out over the time. So as an example, we use these migas a lot where we have the money, we put a hundred thousand in, it's gaining over five and a half percent and it's compounding on itself and we get to the future and now it's time to start creating income out of this. If you transfer that over into an immediate annuity, so a different type of annuity that then sends the payment out, you can actually set up a way where then they will go and sort of, each payment will be partially taxable, partially return of principal. And so as opposed to just pulling the interest out first, it's a way to spread out the taxation. So a lot of times we'll come up with a strategy where we build this MIGA where we're trying to defer the income because they might be in high income earning years, but we're looking to the future where their income is going to come down, but then we want to spread out the taxation. We can roll it into an immediate annuity and again, spread those taxes out over the life of that contract. So that could be somewhat confusing.

If you have questions, call us. I can sort of walk you through your specific example, but annuities are a great way to use as a way to defer taxes now, as long as we have a plan to what to do with them in the future. Well, yeah. And so the point being that the growth or the interest portion of the thing, even though it's deferred, somebody's going to pay tax on that sooner or later. Either you are or your beneficiaries are. If it's not used for long-term care, if it's for long-term care, potentially nobody might pay tax, but generally speaking, someone's going to pay tax on that growth.

Sure. And now we move to life insurance. And with life insurance, you can't put IRA money into life insurance.

Just can't be done by definition. You can take withdrawals out of your IRA, pay the taxes and take the net and stuff it into life insurance. And we do that for a lot of people and it works out quite well, but you just can't take IRA money or 401k money or what is called qualified money and move it into a life insurance. So the money going into a life insurance is post-tax and it creates a basis just like the annuity. It's the money every time you pay a premium that's kept track of and that money, if you withdraw the cash value, comes back to you tax-free.

Okay. And most people don't withdraw the cash value anyhow. Most people just leave the cash value in there. It's earning interest and dividends or if it's an indexed universal life, it's earning interest that's based upon the performance of a stock index. In any case, it's growing and you're getting tax deferral on that growth. And if you pull it all out at once or over time, it's going to be taxed pretty similar to an annuity if you use the cash value while you're alive. Now, there's a way to get around that and it's by taking a policy loan. And many of these life insurance policies are set up with loans and it's zero percent interest. So it's a little complicated to explain that on the radio, but it doesn't cost you net amount any interest because you're effectively borrowing your own money and it doesn't create taxes. And then you'd have the option of paying the money back.

So if you wanted to do a short-term loan to yourself or even a medium-term loan to yourself and then pay it back, you can do that all tax free. Many people borrow from their policies and never pay it back. And as long as the policy stays enforced, it gets paid back or deducted from the death benefit and it's effectively made. So with a life insurance policy, it's possible to actually use the growth of the cash value during your lifetime and never pay taxes on it. I will say you need to tread carefully if you're trying to do this on your own. There are things that you could do to really mess up the benefits of the policy and cause it to potentially lapse or not get the benefits you're wanting for.

So don't try it on your own. But when structured properly, life insurance can be a great place to set money aside in a tax-advantaged way, access it tax-free, and then eventually your beneficiaries are going to get that money tax-free when done properly. So we use this, you know, when appropriate, you know, for a very, in some way it's even a better tax strategy than the annuity because there's a way to have that growth never be taxed, whereas the annuity generally, that growth will be taxed at some point. Okay, so let's talk about the hybrid life long-term care and the hybrid annuity long-term care. I mean, first of all, if you just look at the policies that we offer to people and who actually implement this, about 80% of them to 90% are the life long-term care, okay? And then the rest of them are the annuity long-term care. And the reason for that is the life insurance piece is more tax advantageous. It's just because it is, if the person dies without using the long-term care or they use it very little, the beneficiaries are going to get the full amount of the cash value and the death benefit tax-free, okay? With an annuity long-term care, if you don't use it, then the accumulated interest is going to be taxable to the beneficiary.

That's one reason we do that. There's others, and there's underwriting reasons, but the way it's taxed is it's either an annuity or a life insurance policy. It can't be both. And if it's a life insurance policy, it's taxed as a life insurance policy, or it's taxed as a long-term care policy where the long-term care benefits are tax-free. If it's an annuity long-term care, it's taxed as an annuity and just where you're going to have to pay tax if you withdraw the accumulated interest. But most people don't take withdrawals from these hybrid things. They just wait to use it for long-term care. And any money coming out of these that's paying for long-term care benefits is tax-free anyhow. I think that's a very good point. These hybrid long-term care, you really wouldn't want to put money in one of these policies if you thought you might need it in the future. There are ways to get it out if you put it there.

But when we're doing this in our planning, we really have a pretty high certainty that they're not going to need these funds that we're setting aside. And when it comes out for long-term care benefits, it's tax-free, which is very nice. And so, again, it's another way to do it. It's very beneficial. Long-term care is one of the biggest risks that you're going to face. So planning for it is a big part of our practice.

Yeah. And unfortunately, we've run out of time again before we ran out of show, but we want to encourage everybody like, wow, there's so much information on these topics. They're at cardinalguide.com. If you go there, you're going to find the seven worries tabs.

And this one, of course, is taxes. And this show on income tax and life insurance, annuities, and hybrids is all a wonderful YouTube video with show notes, all sorts of details, as well as Hans' book, The Complete Cardinal Guide to Planning, Foreign Living, and Retirement, with all sorts of strategies to take care of these very issues. And again, my favorite part is 1-800-HANS, right? You can see the number to reach either Hans or Tom, both amazing resources for you as they talk about a lot of this stuff you don't want to try at home anyway. So again, cardinalguide.com. Thank you guys.

Just wonderful time again. Thank you. Thank you. Information Express does not take into account your specific situation or objectives and is not intended as recommendations appropriate for you. Before acting on any information mentioned, please consult with a qualified tax or investment advisor to determine if it's suitable for your specific situation.

Finishing Whale is designed to provide accurate and authoritative information with regard to the subject covered. Investment Advisory Services offered through Brookstone Capital Management LLC, abbreviated BCM, a registered investment advisor. BCM and Cardinal Advisors are independent of each other.

Insurance products and services are not offered through BCM but are offered and sold through individually licensed and appointed agents. Cardinal Advisors is not affiliated with or endorsed by the Social Security Administration or any other government agency. We hope you enjoyed Finishing Whale brought to you by cardinalguide.com. Visit cardinalguide.com for free downloads of this show or previous shows on topics such as Social Security, Medicare, IRAs, long-term care, life insurance, investments, and taxes, as well as Hans' best-selling book, The Complete Cardinal Guide to Planning for and Living in Retirement and The Workbook. Once again, for dozens of free resources, past shows, or to get Hans' book, go to cardinalguide.com. If you have a question, comment, or suggestion for future shows, click on the Finishing Whale radio show on the website and send us a word. Once again, that's cardinalguide.com. Cardinalguide.com. This is the Truth Network.