How a stalwart product continues to survive to the test of time
by Herbert K. Daroff, J.D., CFP®, AEP®Mr. Daroff, a contributing editor for this magazine, is affiliated with Baystate Financial Planning, in Wellesley, Ma. Visit www.baystatefinancialplanning.com
In a world of economic (tariffs, etc.) and political (Brexit, etc.) turmoil, including changes in income taxes and estate taxes, an urgent question to pose to your clients is: what is going to happen to your children’s (or grandchildren’s) education funds, your business, your retirement savings? Within the answer to this question lies an important fact: whole life insurance dividends and cash value have stood the test of time.
Think of a particular country’s military knife with multiple blades:
One blade is the cash value
Compare today’s low interest rates on cash (which are taxable, too) to the internal rate of return on cash value (accessible tax-free) funded with dividends from insurance companies that have consistently paid dividends in up markets and down. Cash value is a great alternative to cash in the bank. As interest rates rise, the value of bonds declines. However, as interest rates rise, the dividends paid on cash value also tend to rise. Cash value is like a personal Roth account or 529 education savings plan, without the contribution and distribution limitations. After-tax dollars grow tax-deferred and are accessible tax-free, for any purpose, not just for education or retirement.
If any of your clients keep large amounts of cash on their balance sheet, for example for construction bonding, consider dollar cost averaging their cash into cash value.
If you have individual clients who are keeping a great deal of cash on the sidelines due to market concerns, consider dollar cost averaging their cash into cash value.
Keep in mind, that your client does not have to be the insured. They can insure anyone with whom they have an insurable interest. For example, they could insure their daughter with the cash value planned to fund their grandson’s education. However, that cash value could be used by the grandfather for his own retirement. This is especially valuable in years that follow market declines, especially double-digit market declines. He could take only the required minimum distribution from his retirement accounts and then take the balance of his cash flow needs from the cash value, rather than taking his full retirement cash flow from a market depressed account.
There is an ad that I hear on the radio about famous people who saw double-digit returns in great years and did not lose money in down years. Turns out that those famous people all used cash value to help their future endeavors. Walt Disney borrowed from his life insurance to start Disneyland. J. C. Penney borrowed from his life insurance policies to fund payroll. Senator John McCain launched his presidential campaign using his life insurance policy as collateral.
One blade is disability insurance
If you policy has waiver of premium in the event of disability, your premiums are funded even if you are unable to work due to injury or illness. With whole life insurance, your cash value continues to grow. Some insurance companies let you convert a term insurance policy with waiver of premium in the event of disability to a whole life policy, even their high cash value short pay products such as 10 or 20 pay whole life or life paid up at 65.
One blade is long-term care insurance
Your life insurance policy can include the ability to access not only the cash value, but also a portion (sometimes up to 90%) of the death benefit for qualified custodial care expenses, tax-free. This access to cash flow provides the dignity to remain in your own home for long-term care. Or, it can be used for nursing home care. With level death benefit universal life, the long-term care benefit remains level, even as the costs of custodial care continue to increase. With whole life, using the dividends to buy paid-up additions, the death benefit continues to grow. Therefore, the access to death benefit for custodial care continues to grow, as well.
One blade is death benefit
The proceeds from a life insurance policy can be used to provide liquidity to an estate to pay estate taxes, if any. Those proceeds can also be used to fund the income taxes on a Roth conversion at death by a surviving spouse. Then, the surviving spouse would have a stretch-Roth, with no required minimum distributions. When the Roth is inherited by your descendants, they have required minimum distributions, but the taxes have already been paid. Death benefits, of course, can also be used to reduce outstanding loans.
Life insurance proceeds can be given to charity. What’s the best asset to give to charity at death? Retirement Accounts and/or Life Insurance. But, in what estate planning document do you usually find charitable bequests? The Will. However, the Will does not control the distribution of Retirement Accounts or Life Insurance. They are controlled by beneficiary designations.
10 Pay Whole Life
I ran a 10 pay whole life illustration the other day for a healthy 40-year old with a $10,000/year premium. Total lifetime outlay $100,000, unless they die before the tenth year. The death benefit started out at nearly $250,000. Certainly, more initial death benefit could be created with other products. This policy’s death benefit was projected (not guaranteed) to grow using dividends purchasing paid-up additions to:
Nearly $ 300,000 by year 10 (age 50)
Nearly $ 375,000 by year 20 (age 60)
Nearly $ 490,000 by year 30 (age 70)
Nearly $ 650,000 by year 40 (age 80)
Nearly $ 850,000 by year 50 (age 90)
Nearly $1,100,000 by year 60 (age 100)
At age 90, that’s about a 4.8% net after tax return, at today’s dividend rates (and interest rates). If you were in a tax bracket (Federal and State) of about one-third, you would need to earn 7.2% pre-tax, today. As interest rates rise, at least in the past, dividend rates have also risen. The actual death benefit may be higher. Of course, past performance is no indication of future results.
The cash value could be used during lifetime to fund education expenses, retirement income, custodial care, and so much more.
Therefore, Whole Life Insurance with:
- dividends buying paid-up additions,
- waiver of premium, and
- access for long-term custodial care
is really Financial Security Insurance, during lifetime and at death.