A life insurance tax shelter uses investments in life insurance to protect income or assets from tax liabilities. Life insurance

Life insurance

Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person. Depending on the contract, other events such as terminal illness or critical illness may also trigger...

proceeds are not taxable in many jurisdiction

Jurisdiction

Jurisdiction is the practical authority granted to a formally constituted legal body or to a political leader to deal with and make pronouncements on legal matters and, by implication, to administer justice within a defined area of responsibility...

s. Since most other forms of income are taxable (such as capital gains, dividend

Dividend

Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...

s and interest

Interest

Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....

 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

In those jurisdictions where life insurance proceeds are only tax free at death, tax liabilities that come due at death are often offset by a policy of the same size. Since the mathematics required to compare different strategies is quite complex, most consumers defer to an accountant

Accountant

An accountant is a practitioner of accountancy or accounting , which is the measurement, disclosure or provision of assurance about financial information that helps managers, investors, tax authorities and others make decisions about allocating resources.The Big Four auditors are the largest...

 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, assume that an individual is likely to owe $100,000.00 in taxes at death. If a permanent life insurance

Permanent life insurance

Permanent life insurance is a form of life insurance such as whole life or endowment, where the policy is for the life of the insured, the payout is assured at the end of the policy and the policy accrues cash value....

 policy with a $100,000.00 death benefit costs $1,000 per year (remaining level for life), and the life expectancy of the person is 30 years, then the following events could occur.

• The individual could die early. In this case, it is unlikely that any alternative investment of the $1000 per year would have yielded the required $100,000.00 at death.
• The individual could live much longer than expected. The individual could have built up a significant cash value within the policy, depending on investment selection. As such, the individual would have access to these cash values tax-free regardless of growth, provided it is set up properly.

Since one normally does not know which of these will occur (see adverse selection

Adverse selection

Adverse selection, anti-selection, or negative selection is a term used in economics, insurance, statistics, and risk management. It refers to a market process in which "bad" results occur when buyers and sellers have asymmetric information : the "bad" products or services are more likely to be...

) calculations must be based on expected life expectancies for people of similar gender, physical condition, and behaviour.

Life insurance to shelter investment growth and income

In an attempt to achieve the "best of both worlds" (protection in the case of early death, and additional tax-protected returns in the case of long life), life insurance policies were created containing investment accounts having preferential tax treatment.
This is most often done with a Variable universal life

Variable universal life insurance

Variable Universal Life Insurance is a type of life insurance that builds a cash value. In a VUL, the cash value can be invested in a wide variety of separate accounts, similar to mutual funds, and the choice of which of the available separate accounts to use is entirely up to the contract owner...

policy. See that article for some discussion of the tax issues.