No one is saying that permanent whole life insurance is the greatest invention since the wheel was created. But this estate planning concept—which has seemingly been around since the dawning of time—does offer significant financial and tax benefits.

Background: Although there are many variations of permanent whole life insurance, let’s stick with the basics. Typically, you take out a policy on the insured’s life that remains in force as long as you pay the premiums. Meanwhile, the policy builds up a cash value you can borrow against, if needed. Alternatively, you may claim the accumulated cash value minus any applicable charges or fees if you surrender the policy. If you keep paying premiums, or if the policy is completely paid up, your beneficiaries ultimately receive the death benefit.

This can help a family cope during tough times. The funds generally are accessible shortly after the death of the insured.

How much does life insurance cost? It varies widely based on factors such as the amount of coverage, your age, health and family history. But you can generally find a policy with a reputable insurer that is affordable for your situation.

Now we’ll get to the tax consequences. First, let’s start with federal income taxes. Although Congress has chipped away at many traditional tax shelters in recent years, the main benefits of life insurance remain intact. Notably, it provides the following tax breaks.

  • No income tax when you acquire the policy.
  • No income tax when cash value builds up within the policy.
  • No income tax when the death benefit is paid to beneficiaries.

In other words, life insurance is completely exempt from income tax. This generous tax treatment is especially attractive to upper-income taxpayers. Currently, the top income tax rate is 37%, plus certain high-income individuals may have to pay an extra 3.8% “net investment income tax” (NIIT) on a portion of investment earnings. When you add the NIIT to the top tax rate, you could be paying tax on some income at a 40.8% rate, not even counting state income taxes.

Finally, it’s not unusual for those in high-tax states like New York, California and New Jersey to end up paying more than 50% overall on their top dollars!

Next, let’s turn to federal estate taxes. Life insurance proceeds will be included in your taxable estate if you own the policy or otherwise posses any “incidents of ownership,” such as the right to change beneficiaries. But this result can easily be avoided by transferring ownership of the policy to an irrevocable life insurance trust (ILIT).  Furthermore, even if the proceeds are subject to estate tax, a generous $10 million exemption (indexed to $12.92 million in 2023) can cover the liability.

(The exemption is scheduled to revert to $5 million, plus inflation indexing, in 2026,)

Practical approach: Consider use of life insurance in your plan. Don’t forget to factor taxes into the equation.