Have you ever wondered how you can get life insurance for free? I’m not talking about getting free life insurance from work. It usually isn’t enough. I’m talking about how to get free life insurance outside of work.
My wife and I have life insurance because with have two young children, a complicated net worth, and mortgage debt. Having life insurance will buy time for our survivors to sort everything out after one or both of us passes.
Because we have more assets than liabilities, we could technically self insure (not have insurance). However, the value of our life insurance insurance policies is actually worth much more than the stated death benefit.
Renewing our life insurance policies and creating death files have reduced our stress as parents. Please get on them if you haven’t done so already.
If you’re still dragging your feet, let me go through a thought process on how to get life insurance for free. The thought process might make you hate income taxes less. Further, it might also motivate you to make more money to better take care of your family.
Life Insurance Benefits Are Usually Not Taxable
To first understand how to get life insurance for free you must first understand the tax liability of a death benefit. Life insurance proceeds are not taxable with respect to income tax. So long as the proceeds are paid out entirely as a one-time, lump-sum payment, no taxes are owed.
You could also decide for your beneficiaries to receive life insurance payments in a series of installments. In such a scenario, the insurer will typically pay interest on the balance outstanding. This would mean the beneficiary would have to pay income tax on the interest.
But in the vast majority of cases, life insurance proceeds are paid in one lump sum. Therefore, your beneficiaries should have no interest on which to pay income tax.
The higher your marginal income tax rate, the more valuable your life insurance policy is. In other words, the more money you make, the higher the probability you are getting life insurance for free.
Estate Tax Considerations For Life Insurance
Estate taxes are a different type of tax liability to consider. When you pass away, the executor of your estate will have to file IRS Form 712 as part of your estate tax return. Form 712 states the value of your life insurance policies based upon when you died.
If your spouse is your beneficiary, the life insurance payout is not taxed. It will be passed on to them fully, along with the rest of your estate that was left to them. Spouses typically have an unlimited exemption with regard to estate taxes.
If your beneficiary is anyone besides your spouse, such as a child or parent, your life insurance payout will typically be added to the value of your estate.
So long as the total value of your estate is less than the federal and state tax exemptions, your estate won’t have to pay any taxes. However, any amount over the exemption will be subject to estate and inheritance taxes.
Latest Estate Tax Threshold
- Federal Estate Taxes – The value of your estate that exceeds $12.06 million per individual will be subject to a 40% estate tax rate in 2022.
- State Estate & Inheritance Taxes – There are 18 states, plus D.C., with an inheritance or estate tax. The estate tax exemption amount varies by state, but typically ranges from $1 million to $2 million. Tax rates can be as high as 20% depending upon where you live.
In other words, so long as your estate is less than $12.06 million per person when you die, you won’t have to pay estate taxes. However, beware of your state’s estate and inheritance tax policies.
How Life Insurance Gets More Valuable
Always calculate how much in gross income you need to earn to pay for that something. As soon as you start thinking this way, you will be more judicious with your spending habits.
When it comes to determining the amount of life insurance coverage, you should think similarly. How much do you need to earn before taxes in order to pay out the death benefit amount?
Let’s say you get a 30-year, $1 million term policy for $50 a month when you are 30 years old. 30 years at 30 years old is the ideal age and duration for a life insurance policy in my opinion. Your estate is also well below the estate tax threshold.
Here is the value of your $1 million term life insurance policy based on your effective tax rate.
- If you pay a 0% effective tax rate, then the value of your $1 million life insurance policy is $1 million.
- If you pay a 10% effective tax rate, then the value of your $1 million life insurance policy is $1.111 million.
- If you pay a 12% effective tax rate, then the value of your $1 million life insurance policy is $1.136 million.
- If you pay a 15% effective tax rate, then the value of your $1 million life insurance policy is $1.176 million.
- If you pay an 18% effective tax rate, then the value of your $1 million life insurance policy is $1.219 million.
- If you pay a 20% effective tax rate, then the value of your $1 million life insurance policy is $1.250 million.
- If you pay a 23% effective tax rate, then the value of your $1 million life insurance policy is $1.298 million.
- If you pay a 25% effective tax rate, then the value of your $1 million life insurance policy is $1.333 million.
- If you pay a 28% effective tax rate, then the value of your $1 million life insurance policy is $1.389 million.
- If you pay a 30% effective tax rate, then marginal income taxes, then the value of your $1 million life insurance policy is $1.428 million.
- If you pay a 35% effective tax rate, then the value of your $1 million life insurance policy is $1.538 million.
- If you pay a 40% effective tax rate, then the value of your $1 million life insurance policy is $1.666 million.
- If you pay a 45% effective tax rate, then the value of your $1 million life insurance policy is $1.818 million.
- If you pay a 50% effective tax rate, then the value of your $1 million life insurance policy is $2.000 million.
In other words, if you pay a 30% effective tax rate, you would need to earn $1.428 million to net $1 million to give to your beneficiaries. Therefore, life insurance gets more valuable the higher your income.
How To Get Life Insurance For Free
The value of a life insurance benefit increases the higher our effective tax rate. Now let’s calculate how to get life insurance for free. Your goal is to get free life insurance and live beyond the life insurance coverage period.
Take the difference between the gross income you must make to pay out the death benefit and the death benefit amount. Now compare the difference with the premiums you pay for your life insurance policy.
For example, let’s say you pay a 20% effective tax rate and have a $1 million term policy. To pay out a $1 million death benefit if you didn’t have insurance means you need to make $1.25 million. Take $1.25 million gross income minus $1 million death benefit = $250,000. $250,000 is the amount of taxes you had to pay.
Now take $250,000 in taxes you paid and subtract it from the amount of life insurance premiums you would pay for the life of the policy. If the difference is greater than 0, then you were able to get life insurance for free.
If you get a 30-year, $1 million term policy at age 30, you will likely pay between $500 – $1,000 a year, depending on your health. If you multiply $500 – $1,000 by 30, the life of the term policy, you get $15,000 – $30,000. You can do the same math with a shorter term policy as well.
$15,000 – $30,000 is clearly less than $250,000 in taxes. Therefore, the cost of having a life insurance policy is free if you die within the term. In fact, you end up making money equivalent to the death benefit minus the premiums paid. But we already know this.
Of course, if you manage to live past your life insurance term, as most people do, then you lose $15,000 – $30,000 from life insurance premiums. But that’s not a big price to pay to help protect your family for 30 years. It’s a fantastic deal, especially because you get to live!
HENRYs Are The Target Demographic To Have Life Insurance
HENRY stands for “High Earner, Not Yet Rich.” A typical HENRY might earn a top one percent income for their age of $200,000 – $800,000. However, they might feel a lot of low-level anxiety because their net worth isn’t large enough yet.
Although HENRYs are making a good amount of income, they are often working long hours and constantly stressed out. By the time HENRYs reach 40, they might start questioning the purpose of grinding so much. Paying a high tax rate while exhausted daily is no fun.
With potentially young children and older parents to care for, HENRYs are in the sweet spot for getting life insurance. Most HENRYs I know pay at least a total 20% effective tax rate. Many also work in expensive cities with heavy tax burdens.
Therefore, the value of their life insurance policy is usually at least 20% greater than the death benefit. This means the life insurance policy will end up free if they die before the term is over. As a result, it would be foolish not to have at least some life insurance at this stage.
Between the ages of 30 – 60 is when life is most complicated, and potentially most risky. Normally, we can’t draw from our 401(k)s and IRAs before age 59.5. Further, the earliest you can take Social Security is 62. Having a valuable life insurance policy to support you through your more demanding years is a smart move.
Does A High Income And Rich Person Still Need Coverage?
Let’s say you do have a top one percent net worth of at least $11 million. Further, your asset-to-liability ratio is at least 10:1. You’re also earning a top income. Do you still need life insurance?
Probably not. If your estate is producing enough passive income to cover your family’s living expenses, it can usually continue, untouched. Worst case, the executor of your trust can sell an asset to cover your estate’s liabilities.
Even though you have a high income and a high net worth, life insurance is still nice to have. First, you’re getting better value for the life insurance death benefit you’re paying. Paying a high marginal income tax bracket is the reason. But most importantly, you have an additional financial buffer which will pay for survivors time to grieve.
We sometimes make rash decisions during emotional times. And the grieving process might take months, if not years to complete. A life insurance benefit may help keep things steady during this time.
Coverage Is Worth It For My Family
To me, life insurance is worth at least 1.5X its actual death benefit. In other words, a $1 million term policy is really worth $1.5 million to my family or more. Therefore, I plan to keep owning life insurance until my kids graduate from college. By then, my mortgages will certainly be paid off as well.
Life insurance minimizes disruptions in an already disrupted life. If you’re looking for competitive life insurance quotes all in one place, check out PolicyGenius. My wife was recently able to double her life insurance policy for less with PolicyGenius. And together, we feel more relief because we now have the same amount of coverage.
Readers, did you realize life insurance is more valuable the more you make? What are some holes in my logic in getting free life insurance based on tax rates? What do you think of the HENRYs being the target demographic to get life insurance? Join 50,000 others and sign up for my free weekly newsletter.