James, You Will Love This

Feb 15, 2007

  1. Guest
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    James,

    I just found this article from the New York CPA society. It validates your belief in the strenght of whole life.

    Now, realize it is a bit dated, but, the premise still is still worth considering. It is dated in the fact that it refers to a $2,000.00 IRA limit. If anything, current conditions make this article an even better case for individuals maiking too much too contribute to IRA's (your circle of influence at the hospital?).

    Also, in that the tax rate has changed; lower now. Nevertheless, I think this shows that buy term and invest the difference is NOT a slam dunk that applies unquestioningly as so many people would have you believe is the gospel truth.

    If with lower tax rates this alters the equation a bit, I think there are other attributes that still are worthy of consideration which make WL a very real candidate for consideration:

    1. Diversification of assets.
    2. Obviously the fact that one has permanent life insurance.
    3. The CV is safe from creditors and judgements.
    4. Emergency access to cash.
    5. Can be used as collateral for loans.


    The CPA Journal Online

    Insurance - a comparison to IRA accounts. (Individual Retirement Accounts) (Personal Financial Planning) by Adelmann, Richard L.


    Abstract- Insurance may prove an alternative to Individual Retirement Accounts, the tax advantages of which were curtailed by the Tax Reform Act of 1986. Variable life insurance and variable annuities offer investors the benefits of enjoying higher returns than whole life insurance. Both allow investors to direct the value of their investment into a variety of investment pools similar to mutual funds. Variable life insurance policy holders are able to borrow on cash values tax-free. Investor borrowing from an annuity before reaching the age of 59 and 1/4 incurs a tax penalty because the borrowed funds are treated as a withdrawal. Younger investors with children, a mortgage, and heavy debts should be advised to opt for variable life while older investors who have substantially retired their debts should be advised to opt for a variable annuity.


    The 1986 tax reform severely curtailed Individual Retirement Accounts (IRAs). There have been recent discussions in Washington, DC, to improve the tax benefits of IRAs. By the time this article is published, some action may have been taken.

    Oddly enough, the tax deduction for $2,000 IRA contributions was never as powerful as the tax deferral on interest, dividends and capital gains inside the IRA. For example, if a taxpayer could have started an IRA at age 28 and contributed $2,000 per year for 37 years, the total contribution of 74,000 would only have generated $37,000 in federal tax savings even at the maximum 50% tax rate in effect in 1985. Over the same 37 years, if the funds could have been invested at 12% (the compound growth rate earned over the last 25 years by average equity mutual funds) the IRA would have grown to $1,363,780. That means an additional $1,289,780 of tax-deferred income between ages 28 and 65. Furthermore, the tax deferral could continue beyond age 65 to 70-1/2! After age 70-1/2 the deferral continues except for the mandatory distributions based on life expectancy.

    While taxpayers and planners have verbalized the loss of a few thousand dollars of lifetime deductions, they may have overlooked the opportunity to defer tax on many dollars of interest, dividends and capital gains.

    Insurance may provide the overlooked answer. Unlike IRA accounts, insurance has no $2,000 contribution limit and no requirement to withdraw at age 70-1/2.

    Comparison Of Life Insurance Products that Shelter Income

    Whole life insurance is a level-pay contract which is guaranteed by the entire net worth of the life insurance carrier, and possibly by a reinsurer. The guarantee is that if the owner pays the scheduled premiums, upon the insured's death the carrier will pay the face amount of the policy to the named beneficiary. To counteract the fact that the annual risk of mortality increases with age, the insurance company collects extra premium in the early years of the policy and puts it into a cash value account where it earns interest. The cash value belongs to the policy owner and is always available by loan or upon surrender of the policy.

    The cash value account works two ways to keep the premium level: 1) The interest earned on the cash value helps pay the rising cost of the increasing risk; and 2) since the face amount of the death benefit is fixed, the cash value funds part of the benefit, so the insurance company's risk is only the unfunded portion. The policyholder is buying progressively less insurance as it gets more expensive. By age 95 or 100 the cash value account equals the death benefit. The actuaries have it all worked out.

    The guarantees in whole life insurance are frequently criticized because they only guarantee that the cash value will earn 4.5 or 5%. The pricing is criticized because insurance company actuaries assume that modern medicine will make no further progress in extending life expectancies beyond what was average in 1980. In spite of screening for medical problems and dangerous hobbies, the actuaries assume their preferred insurers will experience the same mortality as the population at large.

    Those criticisms are valid only for the preliminary pricing process. The insurance companies expect to beat every assumption. However, who knows what interest rates the investment people will be able to earn on new premiums received and on earnings reinvested 40 years in the future? Who knows what AIDS and related illnesses will do to life expectancies? If the insurance company achieves lower mortality rates through astute underwriting and achieves higher investment returns than it guaranteed, the difference will be rebated as a dividend in a guaranteed whole life policy from a mutual company or from a participating policy issued by a stock company.

    A financial planner who recommends "buy term and invest the difference" should be prepared to show how his alternative plan can beat the life insurance security with the tax deferred investment growth. In the factual world "buy term and invest the difference" can result in "buy term and skip the advantaged investment."

    Variable Universal Life insurance

    A legitimate criticism of guaranteed insurance is that it missed an opportunity over the last 50 years. Cash values were primarily invested in Treasury bonds and AAA Corporate bonds. Over the last 50 years stocks have outperformed bonds by an average of 3% per year. Investors in whole life insurance have enjoyed lower returns than investors in equities.

    To respond to this criticism, life insurance companies developed non- guaranteed products called "variable" life. Annual premiums are established based on expected rather than guaranteed rates of return and the policy owner is given a choice of investment pools (like a family of mutual funds) ranging from money markets, zero-coupons, junk bonds, blue-chip stock, emerging growth companies, and others. The policy owner can select one or several pools and switch from pool to pool. The frequency of switches is restricted by the policy. If the investment results exceed the return projected when setting the annual premium, the premiums can be reduced or the face amount of the policy can be increased. Alternatively, premiums must be increased or benefits reduced if investment results are unsatisfactory.

    Annuities

    The word "annuity" used to imply the reverse of life insurance. Whereas life insurance exchanged a lot of little payments for one big payout at death, an annuity contract exchanged a lump sum for a lifetime of guaranteed little payouts. Today the term "immediate annuity" is used for the classic annuity, to distinguish it from the many hybrids. Deferred annuities are hybrids which accumulate and compound principal over a period of time before they are "annuitized" or converted into a guaranteed annuity paying a guaranteed income for life and/or a certain period.

    Deferred annuities offer the same guaranteed and non-guaranteed formats as life insurance policies. During the accumulation period there is a small life insurance contract guaranteeing the principal for life regardless of investment results. In a variable annuity the investor is responsible for directing the annuity values into one or more of a variety of investment pools similar to mutual funds (and managed by many of the same managers).

    Tax treatment of withdrawals from variable annuities differs from that for variable life insurance. The variable life policyholder can borrow cash values free of tax if modified endowment rules are avoided. Any borrowing from an annuity is treated as a withdrawal and is subject to income tax and a 10% penalty before age 59-1/4.

    The choice between variable annuity and variable life depends on the investor's profile. A young investor who has acquired more debts (i.e., mortgage) and responsibilities (i.e., spouse and kids) than assets, will need the variable life insurance because of its high death benefit feature. An older investor who has paid down the mortgage and educated the children can avoid the higher mortality charges and get a higher net return with periodic payout in an annuity.

    A planner can counsel the younger investor to convert, by a Sec. 1035 tax free exchange from life insurance to an annuity as the situation changes later in life.

    the classic annuity, to distinguish it from the many hybrids. Deferred annuities are hybrids which accumulate and compound principal over a period of time before they are "annuitized" or converted into a guaranteed annuity paying a guaranteed income for life and/or a certain period.

    Deferred annuities offer the same guaranteed and non-guaranteed formats as life insurance policies. During the accumulation period there is a small life insurance contract guaranteeing the principal for life regardless of investment results. In a variable annuity the investor is responsible for directing the annuity values into one or more of a variety of investment pools similar to mutual funds (and managed by many of the same managers).

    Tax treatment of withdrawals from variable annuities differs from that for variable life insurance. The variable life policyholder can borrow cash values free of tax if modified endowment rules are avoided. Any borrowing from an annuity is treated as a withdrawal and is subject to income tax and a 10% penalty before age 59-1/4.

    The choice between variable annuity and variable life depends on the investor's profile. A young investor who has acquired more debts (i.e., mortgage) and responsibilities (i.e., spouse and kids) than assets, will need the variable life insurance because of its high death benefit feature. An older investor who has paid down the mortgage and educated the children can avoid the higher mortality charges and get a higher net return with periodic payout in an annuity.

    A planner can counsel the younger investor to convert, by a Sec. 1035 tax free exchange from life insurance to an annuity as the situation changes later in life.

    http://www.nysscpa.org/cpajournal/old/08135916.htm
     
    Guest, Feb 15, 2007
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  2. Airborne1
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    1. Not applicable due to current tax law allowing tax deductibility and deferral of qualified money unless you're talking about a nondeductible IRA. Even a Roth IRA guarantees deferral and tax-free distributions if held for 5 years.

    2. Variable Life - Available with No Lapse Guarantees to Age 100, thereby eliminating the risk of increasing premiums as long as "target premium" is met.

    3. Generally a bad idea to go from LI to Annuity just to avoid increasing COIs - Very tax inefficient ! If you are a CPA, you should know why. There's a better way to avoid increasing COIs

    4. Loan rates in Paticpating WL are terrible. Even some non-participating WL have much better loan rates. Just 1 of many reasons to avoid WL like the plague.

    BE CAREFUL WHAT YOU READ
     
  3. James
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    As far as taxation issues go I simply don't concern myself with outside of the obvious. Such as deferred tax free growth and the loan provisions that come out with out triggering a tax event. Yet though I'm not going to sit here and debate tax issues with CPA's. I understand that taxation has changed since 1990 but overall this article is clearly showing that someone would be foolish to at least not consider a CV Life insurance contract as being a worthy vehicle to be in ones portfolio. Let's face it the tax issue may or may not be real for the majority of Americans, if one makes less than a certain amount which is a floating figure depending on a lot of factors the standard deduction overrules the value of Itemization making any tax benefit mute.

    What is significant is this and that is the obvious we all find if we dig into our clients life situation. For the most part this is what I find (and most others that peek into their clients financial situation), mid forties couples have saved very little and need to boost their saving over the next 20 to 30 years in a major way! Now this isn't new, I would bet if you go back in time this has held true, most don't start taking retiement funding seriously till their 40 to 50's. Nurses and Tech's are no different than the general population, while having a nice income of between 40-80 grand a year plus the income of their spouse they are not that bad off. Yet considering their lifestyles money straight from their income will not suffice, so one has to look at their assets such as property or other assets that can be leveraged to kick start their retirement savings and this is attractive to them in many cases if presented with some degree of sanity.
     
    James, Feb 16, 2007
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    Per A1:

    Item No. 1

    I have no idea what you mean. The only pertinent tax changes which I can see must be considered when reading this is: a reduction in the tax rate. As to the fact that now one can deposit more into an IRA - - I don't know that it is a factor.

    Item No. 2

    Fine. This point does not nullify WL from consideration.

    Item No. 3

    Going from VUL to VA.

    (a) Suppose the beneficiary of the VUL pre-deceassed the insured.
    (b) Suppose a need arose abatable through a VA (guaranteed lifetime income?)
    (c) Suppose one reached a point that they wanted to move their funds to an expense ratio friendly investment vehicle ( A Vanguard VA has dirt cheap expenses).
    (d) Suppose someone did not want to go through the gyrations of a "tax free loan."
    (e) Anyone investing in a VUL does not have taxation as their paramount consideration (may be an element of it, but not overiding). There are legitimate ways to defer income taxes by purchasing stock subject only to capital gains. Income may be tax free or deferred by purchase of government bonds.

    Item No. 4

    If you say so. I don't know.

    Other

    I am willing to wager (not really, just an expression) that:

    1. There is more than one CPA in the New York CPA Society that works for an insurance company.
    2. There is more than one CPA that specialize in taxation in the NY Society.
    3. That there are tax attorneys that are CPA's that are in the NY Society.
    4. That there may be some financial planners and financial analysts in the Society
    5. That before something like this is published it is vetted using Society membership, perhaps even peer review (finance professors, tax professors, regular Society members having unique expertise).
    6. There are plenty of CPA's in the Society that would love to make a name for themselves by pointing out a flaw in one of its papers.


    CONCLUSION

    You may disagree with the paper. Fine. If the New York CPA society says permanent insurance is worth considering, it naturally follows that, "buy term, invest the difference," is not a slam dunk no brainer.

    I welcome your comments on WL, either on this thread, or here: http://www.insurance-forums.net/viewtopic.php?t=453&start=10

    Thanks.
     
    Guest, Feb 16, 2007
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  5. James
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    Most people that sell have a favorite product, insurance sales is not an exemption to this rule. I find it interesting how some can take minor points and take a mole hill and make a mountain out of it. Such as the loan rate of most mutual W/L policies. Yet I do understand that the adjustable DB and a low interest on the borrowing is important if one is using the policy for a equity management where getting to the money early on is important. Yet in most cases these issues are not all that important, in these cases I am a strong believer of the Guarantee (not a rider that is often phrase with legalities that most lay people just don't have the time or the energy to decipher) of the W/L is up there in the stratasphere as to importance once one drills down to understanding the client. I find the UL is a product that many will if explained correctly convert to a W/L policy. The wording on such things as the "No Lapse to 100" is a great wedge issue!
     
    James, Feb 20, 2007
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    Per Airborne1:

    Preface

    For anyone reading this, do not trust what you will read. Consult a competernt tax professional for advice.


    Airborne1

    I just read that if someone does a 1035 for a VA, they could quite possibly end up with tax free income - -

    Scenario.

    1. An insured has a VUL. Stock market crashes, or they have chosen lousy investments. Either way, the CV is less than their basis in the policy (amount they have paid in).

    2. They do a 1035 transfer to a VA for the CV.

    3. Since the CV used to pay for the VA is less than their basis, the income from the VA is tax free.
     
    Guest, Feb 21, 2007
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    This paper addresses the circumstances under which a VUL might be better than term (and investing the difference). The conclusion is on page 11.

    http://www.consumerfed.org/pdfs/vulReport0203.pdf

    We have seen no studies that accurately compare VULÂ’s to the alternative of term life plus a mutual fund. The writer
    has performed long-term analyses comparing the following specific alternatives, each of which is low cost: (1) the
    purchase of a low-load Ameritas VUL, held until death, using VanguardÂ’s very low cost, indexed stock separate
    account; and, (2) low cost term life with the difference between each yearÂ’s VUL premium and the term premium
    invested in VanguardÂ’s tax-managed, indexed stock fund. This comparisonÂ’s results might also apply to a VUL
    purchased from a life insurance agent vs. a load-mutual fund purchased from a financial planner. The choice of the
    VUL is better if substantial withdrawals/loans are taken in retirement.
    This is so even though distributions from the
    mutual fund in retirement receive capital gains treatment. If distributions are not needed, and the mutual fund is held
    until death, thereby incurring taxes only on annual dividends and capital gains distributions (which by the nature of a
    tax-managed fund are minimized), the term plus mutual fund choice is better.
    There are many varied buying situations,
    however, and we caution readers that the comparison we made might not apply in a different set of circumstances.


    Moreover, making assumptions about U.S. tax laws for decades into the future is of course potentially hazardous to
    oneÂ’s financial health. Because of the need under current law to retain most cash value policies until death to escape
    income taxes, any attempt to draw conclusions about the wisdom of buying cash value life insurance must carry
    caveats. It appears to be the policy of the Republican Party to abolish capital gains taxes, and who is to say that will not
    be done. If it is, the conclusion in the preceding paragraph that a VUL is better when retirement distributions are taken
    might turn out to be wrong. Consider President BushÂ’s policy to make permanent the elimination of federal estate
    taxes; a little known aspect of that program is that the step-up-in-basis for assets held until death would be eliminated. If
    this happens, the strategy of holding a mutual fund until death to escape capital gains taxes would turn out to be wrong.
    The longer we ponder these imponderables, the firmer we become in our insistence that buyers of cash value policies
    should keep their options open by buying only those policies that have reasonable sales charges, or by stciking to term
     
    Guest, Feb 21, 2007
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    Dang,

    The info in the previous post appears to have been updated. It appears that now, under the present tax code, buy term, invest the difference, may be a better choice

    http://www.consumerfed.org/pdfs/fpaghv_2006_second_revision111306.pdf

    Last page of the paper:

    Miscellaneous. Please see the companion paper of Variable Universal Life. Since the tax law changes of 2003,
    which lowered taxes on qualified dividends and long term capital gains to a maximum of 15%, I have recommended
    against buying VULs – term life plus a low cost Vanguard stock index fund, say, should work better. The same is
    true for Equity-indexed Universal Life (EIULs), which offers returns linked (usually) to the S&P 500 index. That
    index excludes the effect of reinvested corporate dividends, which are on the rise in 2006. EIULs will have
    significant hedging costs, as well, and they are not sold by insurers I care for.
     
    Guest, Feb 22, 2007
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  9. James
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    So should I hope that the Dem's get their way and eliminate the Bush Tax Cuts and start increasing taxes? Yet though if we were smart enough to eliminate the Capital Gains Tax it would create a hell of an investment mecca and a explosive economy!
     
    James, Feb 22, 2007
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    Our moderator does not really like us talking about investing and he is deletion happy; therefore, I do not know if you will ever see this. I did not originally intend to post it here. But since this thread was started as addressed to you, I thought I ran the least risk of deletion here.

    First, let me post the site from which I got the information:

    http://www.lifeinsuranceadvisorsinc.com/articles/professionaladvisors/MakingLifeInsuranceGood.pdf



    Insurance as an Investment with a Low Expense Product: The implication of the
    preceding discussion about the favorable impact of low commissions and low mortality charges
    is that life insurance, under these circumstances, emerges as a most competitive investment.
    That is especially true where (1) the policies are held until death so that insurance proceeds are
    received free of income taxes, or policy values are otherwise withdrawn or borrowed during life
    without tax consequence; and (2) the comparative after-tax or tax-free returns are compared to
    investments with similar risk characteristics.
    In fact, if, as noted above, it is possible to add 200 basis points or more to the returns of
    the standard life insurance policy by taking out most of the commission cost and obtaining the
    benefit of low mortality and expense charges, the tax-free returns of a life insurance policy can
    look very attractive compared to similar investments. If, for example, one considers the possible
    returns from the most competitive whole life policy in the context of other fixed income
    investments, a tax-free yield of 6.5%, or more, should have great appeal compared either to taxfree
    municipal bonds or taxable corporate, U.S. Treasury or other government issues.


    * The previous was from page No. 9 of the link.

    Now, if one could do that, in an LI contract, then as you say, one would be very free to pursue more aggresive investments outside the LI contract.

    James, I am very glad our paths crossed. You sure as heck taught me and motivated me to learn about LI. It truly is a financial swiss army knife.

    I will either soon be banned (because I will not put up with a capricious dictator of a moderator) or will just quit posting, so I wanted to make sure to tell my buddy James good bye. Best wishes to you and your family. Take care. The advice you gave me on my children's policies - - I will always remember you for that and be greatful.

    Take care.
     
    Guest, Mar 4, 2007
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