I was talking with an advisor and he said the commonly used term “Favorable Tax Treatment” about Life Insurance. I stopped him and asked, “What makes it favorable?”
He mentioned the Death Benefit not being taxable. I stopped him. “Why would the Death Benefit be taxable?”
He answered, “Well, it could be a windfall if the client buys Term tomorrow and dies next week”. My answer was that it was not a windfall, it was capital indemnifying future earning potential, a mortgage, a stake in a business, etc. I asked him if health insurance, homeowners, and auto insurance should be taxable and his response was that they were linked to “real objects”. I pressed on whether the loss of earnings was “real” to a family?
We moved to discussing the taxation of the cash value. “Why are the taxes on growth deferred and why are you able to get your money out tax free?” he asked. “You aren’t”, I responded and went further into drawing down cost basis and loans. “Are you be taxed on a mortgage or when you finance a car?”.
Finally, the last real sticking point was that cash is distributed First In, First Out. To which I conceded that there is preferential treatment but isn’t that one of the means the government has of making Insurance more palatable to the everyday citizen? How many fewer people would purchase insurance if they had to pay a 1099 at the end of every year? How many cash value policies would be sold if they were taxed like annuities?
As a society we have agreed that people dying with Life Insurance is preferable to them dying without it. If every time a young earner was killed and their spouse was left with nothing but children, it would tear apart the community. If every business that lacked the capital to maintain operations when an owner died, our corporations would be in shambles.
Personally, I think the trade-off is far skewed towards the benefits society receives from our products than in Life Insurance contract’s ability to defer taxes and distribute FIFO. Which is why I do not consider our products Taxed Favorably. I consider them Taxed Appropriately.