Life insurance is tax-free, which is why many rich people drop serious amounts of cash into it. To understand why the rich buy it, you first have to understand the two fundamental purposes of insurance. First, it was intended for the young and married who have children but little cash and want to protect their family. The second purpose is known as estate conservation. People build wealth through businesses and investments, but most do not realize they are in partnership with the government through what is known as the Capital Gains Tax, where the government owns a piece of their estate.
Depending on how their affairs have been set up, the Capital Gains Tax will take effect when the person dies or after their spouse dies. The tax-free law on life insurance gives everyone but especially the rich, an easy method of creating more wealth free of taxes.
Life insurance becomes a key estate planning tool. If you look at examples of extraordinarily rich people such as James Gandolfini, he will end up giving half of his 70 million dollar estate to taxes because of poor planning. In essence, it uses the death benefit to offset the tax bill because the estate tax will be due when you die. Nevertheless, life insurance pays out after you die, and this allows the insurance companies to pay the bill rather than the heirs.
However, some contracts will not build cash-value like the others. People have to exercise understanding of a policy when purchasing because some life insurance agents are more interested in a commission than giving the right product. People who have a net worth exceeding five million dollars risk half their estate if they do not plan it properly. Creating a trust and buying policies help to mitigate the tax consequences.
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