"Life insurance," to take but one example, "enjoys unique status among financial products." Among its advantages:
1. You pay NO current income tax on interest or other earnings credited to cash value. As the cash value accumulates, it is not subject to current taxation.interested in some life insurance.
2. You pay NO income tax if you borrow cash value from the policy through loans. Generally, loans are treated as debts, not taxable distributions. This can give you virtually unlimited access to cash value on a tax-advantaged basis. Also, these loans need not be repaid. After a sizable amount of cash value has built up, it can be borrowed against systematically to help supplement retirement income and in many cases, never pay one cent of income tax on the gain. Several cautions regarding policy loans: First, loans are charged interest and policy loans can reduce the overall value of the policy. Second, the cash value is potentially subject to income taxes when there is a withdrawal from or surrender of the policy, or if a certain ratio of death benefit to cash value is not maintained. Third, if the policy is a modified endowment contract, the loan may be taxable.
3. Your heirs pay NO income tax on proceeds. Your beneficiaries receive death benefits completely free of income taxation. Therefore, a $500,000 policy delivers $500,000 in benefits with no deductions and no withholding required. Note: This is true with all life insurance policies, both term and cash value.
4. You can avoid potential estate taxes and probate costs on policy proceeds, as long as the beneficiary designations and policy ownership are arranged in accordance with current law. For instance, if you (A) own your policy at the time of your death or (B) make your estate the beneficiary, the policy proceeds will generally be included in your estate at death. This can increase the value of your estate, triggering estate taxes. This situation may be avoided, however, by placing ownership and naming beneficiaries outside your estate. If structured properly, the policy proceeds will not be included in your estate. However, to avoid estate inclusion for existing policies, the policy must be transferred more than three years before your death. Consult your tax and legal advisors regarding your particular circumstances.
This is not only an example of how the state subsidizes the insurance industry, by the way: it's another reason why critics of the status quo and the growing divide between rich and poor ought to spend less time on the topic of higher taxes for the rich -- which they can afford to avoid, not that they shouldn't be raised anyway -- and more time on the policies, including existing incentives in the tax code, that are responsible for actually making them rich.