For many, there comes a point where you’ve maxed out all of the contributions you can make to company-sponsored retirement plans, IRAs and Roth IRAs for the year. For those who would like to make additional investments in their future, there are not many alternatives for investing in a tax-advantaged manner. If you find yourself in this situation, it could make sense to use investment life insurance to supplement your long-term planning needs.

A Variable Universal Life Insurance (VUL) policy is a life insurance policy that offers both a death benefit and an investment feature. When funded appropriately and managed prudently, the policy’s cash value can provide a supplemental income stream to fund future needs such as retirement. Unlike a term life insurance policy that is only designed to provide a temporary death benefit, a portion of the VUL death benefit is designed to actually last until the day you die. For certain high income or high net-worth individuals, a VUL policy can be a tool to diversify your assets from a tax standpoint.

The 3 Types of Investment Accounts

Taxes on accounts that have no tax advantages can erode the returns by as much as 40% (1) or more long term if you are not diligent. Think of this as working for 2-5 years longer just to cover your taxes throughout retirement.

From a taxation standpoint, the type of accounts your investments are held in can be just as important as the selection of the investments themselves. As illustrated below, there are three broad ways in which investment accounts tend to work: tax-deferred, taxable and tax-advantaged.

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For example, consider an investor who holds company stock inside a 401(k) plan and in a brokerage account. The investment type is the same (company stock), but because the account type is different, the taxes owed when the stock is sold or at the time of withdrawal may be very different. If growth is the primary objective for your portfolio, it’s important to take into consideration how your investments are distributed between these 3 types of accounts because taxes can and will impact the overall return of an insufficiently-structured portfolio. Basically, you could be be paying a lot more in taxes than necessary.

VUL is Investment Life Insurance

VUL policies are highly-specialized products that only make sense for a certain cross section of the general population. For many high-income professionals who are relatively young and in good health, the potential benefits of a VUL policy can make it a reasonable alternative to other accumulation vehicles, as it offers the protections life insurance provides to one’s heirs plus a mechanism to save for the future in a tax-efficient manner. The cross section of the population who fit these two needs includes many doctors.

There are many reasons doctors might be interested in utilizing a VUL policy. For one thing, they are typically high income wage earners who easily maximize their contributions to company-sponsored retirement plans and IRAs. Due to their increased income, some families tend to live high-expense lifestyles that require significant replacement income if something were to happen to the doctor in the family. Normally, this lifestyle starts before they have developed their assets enough to “self insure.” Thus, making the dual purpose of life insurance and savings vehicle more attractive. Protection from lawsuits is another reason that some doctors find VUL policies attractive. Doctors are more exposed to the risk of being sued than the average person, and depending on their state of residence, a VUL may be a good way to help shield assets from a lawsuit.

There are risks associated with VUL policies. VULs are life insurance, so they have insurance expenses in addition to investment expenses. The investment options you have access to inside of your VUL are limited to those provided by the insurance company. Further, there is always a chance that Congress could pass legislation that changes the tax-advantaged status of VUL and other forms of life insurance with a cash value. As with any kind of investment account, returns are not guaranteed and there is the potential for losses.

Mitigating the Risks

Using a VUL policy to supplement your long-term planning needs will never be the right route for everyone, but when funded appropriately and managed prudently, a VUL policy can be a good option for providing supplemental retirement income in a tax-efficient manner. The underlying investment options provided by the insurance company are called sub-accounts. Most insurance companies offer a wide variety of sub-accounts that allow you to invest across a wide variety of asset classes. Thus, it gives you the ability to focus on strategically diversifying your retirement portfolio. It’s important to work with insurance companies that provide access to a selection of investment sub-accounts that follow the same overarching investment philosophy you are utilizing for the rest of your retirement accounts.

If life insurance is being used as an accumulation vehicle, it is also important to minimize insurance expenses wherever possible as those expenses eat into potential returns similar to taxes. This is done by using VUL products that are structured to function as accumulation vehicles and not just designed primarily for death benefit protection. When compared to other kinds of life insurance or securities products, VUL policies have many intricacies that are important to understand. It is highly recommended that you seek the assistance of a knowledgeable professional who understands your individual circumstances before using life insurance as part of your retirement planning process.

This article was written by Larson Financial Group, LLC and provided courtesy of Paul Larson, President and CEO. This article if for informational purposes only and should not be construed as tax advice.

Advisory services offered through Larson Financial Group, LLC, a Registered Investment Advisor. Securities offered through Larson Financial Securities, LLC, member FINRA/SIPC.

Larson Financial Group, LLC, Larson Financial Securities, LLC and their representatives do not provide legal or tax advice or services. Please consult the appropriate professional regarding your legal or tax planning needs.

(1)This illustrates the taxation of short-term capital gains at higher income levels as well as the treatment of ordinary dividend income.