Life insurance is one of the most important, but often least understood, tools for financial planning, especially as it relates to estate planning. However, its specific uses are often overshadowed by a marketing strategy that pitches it as a Swiss Army Knife for all financial situations– retirement, estate planning, etc. This is not the case.
While there can be many legitimate uses for whole, variable, or universal life policies for U.S.-based people (Confused? That’s partially the goal, I think, but for more information on the types of available policies, click here.), most Americans outside of the United States frequently find themselves shut out from these policies because of their address. Even if they find themselves able to buy an American life insurance policy outside of the United States, the need to schedule fitness exams, etc. may make actually buying the policy impossible or they will– upon investigation– discover that their whole life policy may run afoul of local regulations, causing major tax headaches.
Some investors will consider buying a whole life policy in their country of residence: however, this may not be a great idea because the whole life policy’s underlying cash value is generally invested in investment funds that are tax toxic from a U.S. perspective, the dreaded PFIC. As noted cross-border Tax specialist Phil Hodgen notes on his blog, the ownership of the underlying assets means:
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You have to file Form 8621 to report all of the mutual funds held as part of the investment account in that insurance policy.
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If, during the time the life insurance policy is active and you are alive, the insurance company buys and sells mutual funds, you will have actual taxable sales under the excess distribution rules.
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When you die, your estate will be treated as having sold the PFICs inside the “insurance policy” for fair market value, again triggering tax under the excess distribution rules.
This information doesn’t include the additional reporting requirements. In his blog, Hodgen goes into more detail on the policy itself and the fact that if the insurance policy doesn’t meet IRS definitions of a life insurance policy, any estate planning benefits will be eliminated.
As we’ll discuss below– while this is annoying– not having a whole life policy is not necessarily a disadvantage for Americans (especially when one takes into account that some of the estate planning strategies embedded in Life Insurance and Life Insurance Trusts will run up against regulations in the country of residence– the dreaded PRIIPS/KIDS). In what has become a cliché, those providing independent advice about such policies for Americans who are not expats generally recommend to “buy term and invest the difference,” and the same holds true for Americans outside of the United States.
(Curious about the definition of term insurance? Click here)
In certain cases, and with a bit of legwork, Americans abroad may find themselves able to buy such a policy in the United States, and they will generally find that any “pure life insurance” product they purchase in the United States will not pose problems in their country of residence. However, Americans should confirm any purchase of such a policy with a tax and legal advisor in their country of residence as local regulations are always shifting.
The second option is to buy such a policy in their country of residence. However, this can be a bit more complicated for several reasons. First, before purchasing, Americans should confirm the policy is a “Pure life insurance” product without additional bells and whistles. Second, it is always encouraged to verify the policy against U.S. regulations, and generally, major insurance suppliers can help with that. An additional concern is the “excise” tax the U.S. charges on Foreign Insurance Policy Premiums– this ranges from 1-4%, but is 1% on pure life policies. However, the U.S. maintains treaty agreements with 17 countries which means that insurers from these countries are generally exempt from the “excise tax,” and the United States maintains a list of foreign insurers who are also exempt from the tax requirements. Consequently, these insurers would be, accordingly, a good place to investigate term life policies. For more information on the tax-related implications of foreign life insurance, we’d recommend this article from U.S. CPA Virginia La Torre Jeker.
No life insurance purchase takes place inside a vacuum and anyone considering a purchase of life insurance should undertake to analyze such a policy in the context of their long-term plans and goals covering the amount of policy recommended (especially to analyze in terms of any public or private pensions available), long-term family goals, determinations regarding long-term residence, etc. While Walkner Condon doesn’t sell life insurance (or any insurance), such discussions and analyses are part of our long-term financial planning process.
For Americans within the United States, the conversation about life insurance can be rather involved, as a variety of options are available and all of these options can be used to solve a variety of issues.
Generally, these options are limited for Americans outside of the United States as while insurers will continue to honor whole or variable life insurance policies for Americans outside of the United States, it is generally much harder for them to write new forms of these policies for Americans living outside of the United States. This generally leads to their option in the United States being term insurance.
Likewise, Americans outside of the United States should likely not invest in more complicated insurance products in our opinion, because these will generally hold assets that are referred to as PFICs (or Passive Foreign Investment Companies) and are taxed at a higher rate.