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This article was featured in Growth magazine, Volume 1, Issue 12.  Growth Magazine is the Business-to-Business resource for The Woodlands and Montgomery County area.

Measuring the True Value of Life Insurance

By Virgil D. Packer, CRFA, Devereaux Investments, Inc.

Life insurance is often misunderstood and rarely fully appreciated for the incredible value that it can offer families. Whether you are just getting started raising a family, starting a business or you are entering into retirement, life insurance can play a valuable role in protecting and safeguarding your interests. Most people do not realize that there are more flexible options available to them than "term"and "whole life" insurance. There are options that exist between these polarities that offer you a way to grow your money while deferring any tax, and to then withdraw your money tax-free. 

 

Consider the flexibility provided by an Indexed Universal Life Insurance Policy as illustrated here:  Aforty year old male, who owns a business, has a family, a mortgage, and 2 kids headed to college in 10 to 12 years might choose to purchase this policy with a death benefit of $300,000, instead of saving $500.00 monthly in a mutual fund or a savings account. If this man continues to pay his premium to age 65, he could then start to withdraw funds from his policy. As long as the policy is structured correctly, i.e. not a Modified Endowment Contract, these funds can be removed from the policy tax-free. The premium may also be written off by the policy owners' company, if the company is paying the premium.

 

By age 65, the owner could begin withdrawing $51,155.00 per year for the next 20 years. This amounts to a total of over $964,108 of tax-free income for a premium investment of $144,567. Upon his death, should he live to his life expectancy of 86, the family would still receive $417,033 in the form of a tax-free death benefit. This means the family took a total of $964,108 in the form of income withdrawals, plus the policy paid a death benefit of $417,033, for a total of $1,381,141 tax-free from this policy. The taxable equivalent required to net the same amount from another investment vehicle such as a retirement account, i.e. IRA, 401k, SEP, SIMPLE etc. would be $2,124,832.30 1

 

But what happens if he dies prior to being able to take withdrawals from his policy? If he dies in year 10, his total premium investment is $60,000; yet his family would still receive the full death benefit of $300,000 tax-free. I have yet to find an investment that will pay you more than your principal and interest. If he dies in year 15, his premium investment is $75,000, and the family gets $300,000. The point is he now has a safety net that protects his family should he suffer an untimely death without sufficient growth of his assets.

 

What happens if this guy's business fails and he has to move his family under a bridge somewhere?

The answer of course will vary based on what year his business fails and where the bridge is located.  Should his business fail at age 60 (20 years into his policy), the projected cash value would be $229,558. He could then surrender his policy and get the entire cash value accumulation of $229,558. There would be tax due on the difference between his premium investment and the surrender value; however, his principal plus a modest growth rate of 2.31% would still be recovered.

 

This type of investment strategy also works remarkably well for parents or grandparents saving for their children/grandchildren's college education. Cash value accumulation held inside of life insurance policies does not enter into the eligibility equation for financial aid, so kids can still qualify for loans and have access to tax-free money for school.

 

Unfortunately, estate taxes are a reality for anyone with an estate exceeding $1.5 million. Life Insurance can also play an important role in offsetting or avoiding these taxes.

 

Consider this hypothetical example: A woman passes away at age 65, and she has an annuity worth $100,000. She originally purchased the annuity for $50,000, so she now has $50,000 worth of principal and $50,000 worth of gain. Should someone in this circumstance die with an estate worthover $1.5 million, the IRS will say, "Of course you owe income tax on the interest you've earned and you owe estate tax on the whole thing�the principal and the interest!' Thus a $100,000 IRA or annuity can be 'double-taxed,' resulting in the heirs receiving only $50,100.

Let's assume that this person had no need to use income from her annuity; the intention was always to leave any assets to heirs. What if we took this annuity and converted to a life insurance policy?  It would buy a policy worth approximately $433,500.2 Now when the policy holder dies, the beneficiaries will receive the full value of the policy ($433,500) and pay zero in income tax because the death benefit on a life insurance policy is free from federal income taxes. If the life insurancepolicy is owned outside of the insured's estate, the estate tax is also zero. If you own IRAs or annuities that are not needed for income purposes, life insurance may be more suitable.

So whether you are only beginning to build your nest egg or you have a well-established retirement that you want to safeguard, life insurance should be an integral part of your overall investment plan. 

 

GROWTH is privileged to publish contributions from expert members of our communities. Mr. Packer may be reached by phone at 281-296-1604, or by email at [email protected].

 

**This article was reprinted with permission from Growth Magazine**

 

* Careful planning by a licensed professional is required to make this strategy work. Also, the purchase of life insurance is subject to health underwriting, so this strategy may not work in every situation. Before purchasing life insurance, you should consider any accompanying expenses, fees, and surrender charges, as well as your ability to maintain continuous premium payments. This example assumes that the purchaser is in good health and qualifies for preferred rates. As premium rates are affected by age, health, smoking status, and other lifestyle factors; actual results will obviously vary from this example.

 

1Vista Elite Series II is a flexible adjustable life insurance with an equity indexed feature from Indianapolis Life Insurance Co. (form 31001F02), November 11, 2005, male, age 40, preferred non-smoker, $500.00 monthly paid for 25 years provides a guaranteed death benefit to age 66 of $453,300 assuming loans of $51,155 annually for 20 years at a minimum interest rate guarantee of 2%. Non � guaranteed Indexed projected value uses 8.3%.  The purchase of life insurance may incur substantial costs, fees and surrender charges.

 

2Converting an annuity to a life policy could involve surrender costs on the annuity and will incur fees and costs for the life policy.  Tax rates used above are 33% income tax (federal plus state) and 40% estate tax. Based on average of 16 leading companies (www.annuityshopper.com) providing monthly annuitization quotes as of 1/14/04 the after-tax value of the annuity is $618 monthly. The $618 (exclusion ratio of 72%) after taxes provides a monthly premium of $561 for life insurance. Based on this monthly premium, 3 companies provided quotation for life insurance as of 1/14/04 of $544,808, $338,178 and $417,621 respectively, average of $433,535