Life insurance proceeds are not taxable in many jurisdictions. Since most other forms of income are taxable (such as capital gains, dividends and interest income), consumers are often advised to purchase life insurance policies to either offset future tax liabilities, or to shelter the growth of their investments from taxation.

Life insurance to cover future taxes

Since life insurance proceeds are normally only tax free at death, tax liabilities that come due at death are often offset by a policy of the same size. Since the math required to compare different strategies is quite complex, most consumers defer to an accountant or life insurance agent for advice. However, there is often vast differences of opinion between these professionals, even given the same starting conditions! This should not be surprising, given the huge future differences that even small variances in starting conditions can make.

For example, lets assume that an individual is likely to owe $100,000.00 in taxes at death. If a permanent life insurance policy with a $100,000.00 death benefit costs $1000 per year (remaining level for life), and the life expectancy of the person is 30 years, then the following events could occur.

  • The individal could die early.
  • The individal could live much longer than expected.

Since one normally doesn't know which of these will occur (see adverse selection or anti-selection) you must base our calculations on expected life expectencies for people of similar gender, physical condition, and behaviour.

Life insurance to shelter investment growth and income