Life Insurance. The Wealth Preservation Institute. St. Joseph, MI

Transcription

1 Life Insurance Inside Qualified Plans Good or Bad? Copyright The Wealth Preservation Institute 3260 S. Lakeshore Dr. St. Joseph, MI

2 Introduction The concept of buying lif e insurance inside qualified plan has been allowed by the IRC for many years. Marketing organizations (IMOs/FMOs) and insurance companies have been pitching LI in QPs fairly heavily since about It was a very hot topic prior to the proposed 412(i) regulations that came ou ut on Friday, February 13, The proposed regs. dest royed what in the industry is known as pension rescue. 2

3 PSP vs. DB Plan Can you buy LI in a profi t sharing gp plan (PSP)? Yes, but that s not typically where you see it purchased (unless you are doing pension rescue). Can you buy LI in a defined benefit (DB) plan? Yes, and this is where you typically will see it pitched. 3

4 Why buy life insurance in a QP? The answer depends on who you ask. Insurance companies like it because life insurance sales are more profitable than annuities. IMOs like it because ther re are bigger commissions and better overrides than with annuities. Insurance agents like it because the commissions i are bigge er and dbetter than annuity sales. What about the client and his/her best interest? 4

5 What s the sales pitch? It s very powerful and attractive to those who have no idea that t buying LI in a QP is terrible idea. If a client buys life insurance inside a defined benefit plan, the deduction can be significantly increased. Buying LI in a PSP does deduction. not increase the 5

6 Continued Ask an affluent client th he following and this is why it s easy to sell LI in a DP plan. Client, would you like to implement a QP where you can take a $205,311 deduction into the plan this year or a $161,203 deduction? d Of course the client is go oing to prefer the higher amount. Why? Because they hate the IRS so much and because they think taking large ta x deductions is a way to stick it to the IRS. 6

7 What s the problem? Wouldn t the client like to know if using LI in a QP makes financial sense? Wouldn t the client like to know if he/she will generate more retiremen nt income because of the larger deduction? Wouldn t the client like to know what will happen to this wonderful DB that he/she just purchased at death? 7

8 New Question Ask your client the following: I have two investments you can purchase. Both cost $100,000. However, in ten years, investment t A will be worth $200,000 and investment B will be worth $150, Which one do you want to purchase? What s the client going to say? Investment A all day long. 8

9 QP Question Now ask your client if he/she would rather deduct $205,000 a year to a QP or $161,000 a year. Throw in the caveat that the retirement income both will be EXACTLY th he SAME! What will the client say? Amazingly, initially iti the cl ient will still opt for the $205,000 deduction because they hate the IRS so much. However, when it is fully explained, virtually all clients will opt for the lower deduction. 9

10 LI is a terrible investment in a QP If you ve read my book Retiring Without Risk ( you ll know that I m a huge advocate of growing wealth with CVL (Retirement Life specifically). However, buying LI in a QP is a terrible idea. Why? LI outside of a QP works as a tremendous wealth building tool because mo oney can grow tax free and come out tax free. 10

11 Continued In a QP, when you remove the money, it is a 100% income taxable. This included money removed from a LI policy owned by the QP. So, the added expenses of a life policy when you can t remove the money tax-free kills its benefit and using an annuity (especially a FIA with GIB) will make more sense. 11

12 Assumed rates of return When constructing a DB plan for clients, you calculate the deduction by the assumed rate of return on the investmentss in the plan. Depending on what inves stments you use, you ll use a different rate of return. In a traditional DB Plan, a56% 5-6% rate of return is typically used when non-insurance products are the assets of choice. 12

13 412(e)3 Plans (formerly 412(i)) When you use a 412(e)3 plan, you MUST use life insurance or annuities as the investment. Insurance agents love this. With guaranteed produ cts you will typical use a 3% rate of return. There are a handful of FI IAs that t have this (even though most agents use traditional fixed annuities). LI policies can also have a 3-4% guaranteed rate of return and therefore can be used in these plans. 13

14 Continued When using LI in 412(e)3 plans, again, there are expenses to the policy that do not exist in an annuity. Annuities may have limite ed or low growth, but there are no mortality or per 1000 charges in the annuities to drive up cost ts. If you illustrate an annuity vs. the typical CVL policies used in QPs, the amount of premium needed to drive the retirement income is significantly ifi less with the annuity. 14

15 Example The example numbers from my previous slides are for a 50-year old who will fund a DB plan each year until age 62 and take retirement t income from 63. The $205,000 annual deduction amount assumes a 3% rate of return during the life of fthe plan (something you can get away with when using certain guaranteed products). The $161,000 number assumes a 5% rate of return (a reasonable rate of return ove er time for a non-guaranteed investment). Both investments will provid e for the client the SAME retirement income. 15

16 Maximum Retirement Income Right now the maximum retirement income is $195,000 a year from a DB Plan. It DOESN T MATTER how much you contribute to a DB Plan, the max. inco ome a client can receive in retirement is $195,000. Therefore, if you can get a $205, deduction because you use a crummy LI policy or a $161,000 deduction whe en using a less expensive annuity, the retirement income is going to be the SAME! 16

17 What is accomplished with the higher deduction? 1) the insurance company is happy 2) the insurance agent is happy 3) the client who is totally ignorant of what s going on gets the short end of the stick. Why? Because the larger deduction did NOT help the client with his/her ultimate goal which is to generate more income in retirement. 17

18 But, but, but I really don t want to hear it from advisors and insurance companies. IT IS NOT better to take a bigger deduction if the ultimate retirement benef fit is the same. I don t care if the client has to take home an extra $41,000 in my example and pay tax on that money. If he/she h is in the 40% income tax bracket, the client still has $24,600 left that can be invested somewhere each year in an effort to grow more 18 wealth.

19 What do you do with the policy in retirement? LI policies in DB plans ca an not be rolled to IRAs. Therefore, the policy is either going to be surrendered (which is a total waste), or it is going to be sold to the client (or an ILIT). If the client dies while the policy is in the plan and has an estate tax problem, the vast majority of the DB is going to get esta te taxed. So congratulations to the advisors who setup these plans and who don t nt know any better, you just guaranteed that most of your clients will have the DB from these plans double taxed at their death. 19

20 Overfunded Plans What happens if you overfund a plan? The excess is hit with a 50% excise tax. Which means if you are in the 40% income tax bracket when removing money from the plan, you will pay a 90% tax on the money withdrawn. 20

21 Final Question Should affluent clients ev ven fund tax-deferred qualified plans in the first place. Mathematically the answ wer is no for clients 55 and under if the goal is maximum after tax income in retirement (see tiringwithoutrisk.com). Should affluent clients ever fund qualified plans? There is an argument that they should never fund qualified plans (except 401(h) plans). Why? Because they are nearly guaranteeing that the money will eventually get double taxed at death. 21

22 I know that I know Ikn now that I don t know I don t know that I don t know 22

23 Questions? Questions? hewpi.org 23