Friday, March 11, 2016
Monday, November 22, 2010
Financial Security in Times of Insecurity
What’s all this talk we’ve been hearing lately on radio ads about “banking on yourself”? You may have heard the ad in which the guy says that if you’re thinking about putting money in the stock market, “Stop!” And then he goes on to say that with his program you can build wealth, not lose money, and even pay yourself interest on car loans. Too good to be true? Well, it’s not as crazy as it sounds.
This “special” investment is nothing more than good old-fashioned whole life insurance set up to maximize cash value growth and take advantage of the special tax treatment afforded to life insurance policies. Before I explain how it all works, a few concepts need to be understood:
Permanent Life Insurance: these kinds of policies are designed to last your entire life time and not expire or require huge increases in premium payments at the end of a term.
Cash Value: this built-in feature of many permanent life insurance policies allows a policyholder to accumulate cash within the policy on a tax-deferred basis.
Tax-deferred: means you don’t pay taxes on gains now but may pay them at some time in the future, if at all.
Guaranteed: refers to the minimum interest rate that the life insurance company guarantees it will pay on the cash value, regardless of the economy or the insurer’s investment returns; usually this will be a conservative amount, say 3% or 4%.
Non-guaranteed: refers to the current rate of interest that the insurer is actually paying right now on policy cash values, and can change depending on the performance of the insurer’s investment portfolio; this rate will often be higher than the guaranteed rate.
Policy Loan: a way of borrowing against the cash value of a life insurance policy at a minimal interest rate, rather than cashing out the policy or taking out a policy withdrawal. Policy loans are not generally taxable, and do not have to be repaid.
Dividend: a policyowner’s share of the insurer’s annual profit that can be added to the policy’s cash value to increase cash value even more than would be earned by the interest rate alone. Dividends are not guaranteed.
So how does this program work? First, you apply for a life insurance policy through a reputable agent or broker from a high quality insurance company. It is important that this policy be properly funded, and this should be discussed with the agent/broker as it is beyond the scope of this short article to explain adequately. But the basic goal is to overfund the policy, meaning you deliberately pay extra money into the policy, over and above the actual premium needed to keep the policy in force.
This extra money goes straight in to the cash value portion of the policy, and allows the policy to grow more cash more quickly than would normally occur if you paid only the required minimum premium. Remember, this cash is growing tax-deferred, so any gains made this year will not be taxed next April 15th. Why is that good? Because you will continue earning interest not only on your principal, but also on the money that you didn’t have to pay to the government as a tax.
To understand why that’s important, think about your regular bank savings account. Each year that you earn a gain in your savings account, your bank sends you a tax reporting statement the following January showing how much interest you earned. Then you have to pay a tax on that gain. By paying this tax you actually lose some of your profit to the government. But because life insurance earns interest on a tax-deferred basis, you don’t have to pay taxes on your interest gains each year. And that means you have more money working for you earning more interest than you would if you had to pay part of the profits to the taxman. This is similar to the benefit you get by investing in a 401(k) or an IRA.
What does this mean in practical terms? Say, for example, that the guaranteed interest rate on the policy is 4% and your combined federal and state income tax rates total 33%. You would need to earn an annual gross rate of about 6% on a currently taxable investment to earn a net of 4% after taxes. On the other hand if you invest money in a taxable vehicle that earned 4% before tax, you’re after-tax gain would be only about 2 1/2%. So what would you prefer? Earning money that’s taxed every year or that is tax-deferred? And at current bank interest rates, can you even get 4% on your savings? Can you get 3%?
Ok, so you have an insurance policy stuffed full of cash and now you want to use some of that cash. Maybe you want to finance a new car, take that round-the-world vacation you’ve promised your spouse, help the kids with a down payment down on a house, or help the grandkids pay for college. How do you do that? And, just as importantly, how do you do that without having to pay all those taxes on your gains that have been accumulating for years? The answer: policy loan.
Unlike a conventional loan from a bank, credit union, or finance company, you don’t have to qualify to borrow against your policy - it’s already your money. All you have to do is contact your agent/broker or the insurance company and request the loan. They’ll send you the appropriate paperwork to sign and you’re all set. No credit checks, no examination of your income and tax returns, no embarrassing questions. And instead of paying the principal and interest to the lender, you pay it back to your policy. That’s right, you pay it back to yourself. Yes, the insurance company takes a small portion of the monthly pay-back amount, and that is good because it allows you to use your money, including your gains, as a loan rather than as an income distribution. Remember, loans are not taxed as long as the insurance company charges interest on the loan principal. And typically the insurer charges only a nominal interest rate, like 2%. Where else can you get a 2% loan interest rate?
But the best part for long-term planning is that policy loans from life insurance policies are not required to be paid back. Yes, you read that last sentence correctly: you don’t have to repay the loan on your policy. All that happens if you don’t repay the policy loan is that when the insured dies, the amount of death benefit that the insurer pays to the beneficiary of the policy will be reduced by the amount of the outstanding loan balance, including the interest due. What does that mean for long-term planning? It means that if you structure your policy correctly, you can use the cash in your policy to supplement your retirement income without having to ever pay a penny of income tax on that money. Savvy investors often buy large life insurance policies specifically to accumulate vast sums of cash to spend later in retirement without having to pay any taxes. (Please consult with an appropriate tax and/or legal professional to determine your specific situation.)
The bottom line is that you can use the special tax benefits of life insurance to finance large purchases as well as provide supplemental retirement income, all while saving taxes. And if there is any money left in your policy when you die, your designated beneficiary can receive the remainder of the policy without tax liability. (Again, please consult your tax professional for guidance for your particular situation.)
For further information on this concept or other insurance planning strategies, please contact Scott Semel, LUTCF (CA Lic# 0C67540), at 818-538-9321, ssemel@yahoo.com or www.scottsemel.droppages.com.
This “special” investment is nothing more than good old-fashioned whole life insurance set up to maximize cash value growth and take advantage of the special tax treatment afforded to life insurance policies. Before I explain how it all works, a few concepts need to be understood:
Permanent Life Insurance: these kinds of policies are designed to last your entire life time and not expire or require huge increases in premium payments at the end of a term.
Cash Value: this built-in feature of many permanent life insurance policies allows a policyholder to accumulate cash within the policy on a tax-deferred basis.
Tax-deferred: means you don’t pay taxes on gains now but may pay them at some time in the future, if at all.
Guaranteed: refers to the minimum interest rate that the life insurance company guarantees it will pay on the cash value, regardless of the economy or the insurer’s investment returns; usually this will be a conservative amount, say 3% or 4%.
Non-guaranteed: refers to the current rate of interest that the insurer is actually paying right now on policy cash values, and can change depending on the performance of the insurer’s investment portfolio; this rate will often be higher than the guaranteed rate.
Policy Loan: a way of borrowing against the cash value of a life insurance policy at a minimal interest rate, rather than cashing out the policy or taking out a policy withdrawal. Policy loans are not generally taxable, and do not have to be repaid.
Dividend: a policyowner’s share of the insurer’s annual profit that can be added to the policy’s cash value to increase cash value even more than would be earned by the interest rate alone. Dividends are not guaranteed.
So how does this program work? First, you apply for a life insurance policy through a reputable agent or broker from a high quality insurance company. It is important that this policy be properly funded, and this should be discussed with the agent/broker as it is beyond the scope of this short article to explain adequately. But the basic goal is to overfund the policy, meaning you deliberately pay extra money into the policy, over and above the actual premium needed to keep the policy in force.
This extra money goes straight in to the cash value portion of the policy, and allows the policy to grow more cash more quickly than would normally occur if you paid only the required minimum premium. Remember, this cash is growing tax-deferred, so any gains made this year will not be taxed next April 15th. Why is that good? Because you will continue earning interest not only on your principal, but also on the money that you didn’t have to pay to the government as a tax.
To understand why that’s important, think about your regular bank savings account. Each year that you earn a gain in your savings account, your bank sends you a tax reporting statement the following January showing how much interest you earned. Then you have to pay a tax on that gain. By paying this tax you actually lose some of your profit to the government. But because life insurance earns interest on a tax-deferred basis, you don’t have to pay taxes on your interest gains each year. And that means you have more money working for you earning more interest than you would if you had to pay part of the profits to the taxman. This is similar to the benefit you get by investing in a 401(k) or an IRA.
What does this mean in practical terms? Say, for example, that the guaranteed interest rate on the policy is 4% and your combined federal and state income tax rates total 33%. You would need to earn an annual gross rate of about 6% on a currently taxable investment to earn a net of 4% after taxes. On the other hand if you invest money in a taxable vehicle that earned 4% before tax, you’re after-tax gain would be only about 2 1/2%. So what would you prefer? Earning money that’s taxed every year or that is tax-deferred? And at current bank interest rates, can you even get 4% on your savings? Can you get 3%?
Ok, so you have an insurance policy stuffed full of cash and now you want to use some of that cash. Maybe you want to finance a new car, take that round-the-world vacation you’ve promised your spouse, help the kids with a down payment down on a house, or help the grandkids pay for college. How do you do that? And, just as importantly, how do you do that without having to pay all those taxes on your gains that have been accumulating for years? The answer: policy loan.
Unlike a conventional loan from a bank, credit union, or finance company, you don’t have to qualify to borrow against your policy - it’s already your money. All you have to do is contact your agent/broker or the insurance company and request the loan. They’ll send you the appropriate paperwork to sign and you’re all set. No credit checks, no examination of your income and tax returns, no embarrassing questions. And instead of paying the principal and interest to the lender, you pay it back to your policy. That’s right, you pay it back to yourself. Yes, the insurance company takes a small portion of the monthly pay-back amount, and that is good because it allows you to use your money, including your gains, as a loan rather than as an income distribution. Remember, loans are not taxed as long as the insurance company charges interest on the loan principal. And typically the insurer charges only a nominal interest rate, like 2%. Where else can you get a 2% loan interest rate?
But the best part for long-term planning is that policy loans from life insurance policies are not required to be paid back. Yes, you read that last sentence correctly: you don’t have to repay the loan on your policy. All that happens if you don’t repay the policy loan is that when the insured dies, the amount of death benefit that the insurer pays to the beneficiary of the policy will be reduced by the amount of the outstanding loan balance, including the interest due. What does that mean for long-term planning? It means that if you structure your policy correctly, you can use the cash in your policy to supplement your retirement income without having to ever pay a penny of income tax on that money. Savvy investors often buy large life insurance policies specifically to accumulate vast sums of cash to spend later in retirement without having to pay any taxes. (Please consult with an appropriate tax and/or legal professional to determine your specific situation.)
The bottom line is that you can use the special tax benefits of life insurance to finance large purchases as well as provide supplemental retirement income, all while saving taxes. And if there is any money left in your policy when you die, your designated beneficiary can receive the remainder of the policy without tax liability. (Again, please consult your tax professional for guidance for your particular situation.)
For further information on this concept or other insurance planning strategies, please contact Scott Semel, LUTCF (CA Lic# 0C67540), at 818-538-9321, ssemel@yahoo.com or www.scottsemel.droppages.com.
Friday, November 16, 2007
True Love . . .
TRUE LOVE MEANS PLANNING AHEAD – This article from MarketWatch is subtitled “ten ways husbands can help their wives survive widowhood” and here are the 10 ways:
1. Delay retirement
2. Start a business together
3. Cover health-care costs.
4. Talk.
5. Fund a spousal IRA
6. Delay taking Social Security
7. Consider buying a deferred annuity
8. Look at asset titles, beneficiary.
9. Social network
10. Call in an expert.
That’s all 10 of them. Let’s hope the “expert” has enough sense to recommend what should be #1 on this list. Have adequate life insurance!
Study: Family businesses growing steady and strong but face future risks
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Wednesday, June 23, 2004
Guaranteed Retirement Income - No Market Risk
Hedging against an uncertain future.
From The Tax Adviser:
The Section 412(i) Retirement Alternative
Recent stock market declines have triggered substantial losses for many retirement plans, leading clients to rethink investment strategies and life insurance companies to tout IRC section 412(i) plans as a way to protect retirement funds. CPAs should review such plans to advise eligible clients.
HOW DO THEY WORK?
Section 412(i) plans are defined benefit pension plans guaranteed exclusively by annuity contracts and life insurance. (Defined benefit plans pay definitely determinable benefits to an employee over a period of years—usually for life—after retirement.) Section 412(i) plans have been around since 1974; in uncertain markets, their guaranteed returns are enticing.
An employer funds such a plan by making annual deductible contributions for eligible workers; the employees are not taxed on the contributions. The plan then purchases from an insurance company annuity contracts with a guaranteed return (generally ranging from 3% to 5%). When a worker retires, the annuity pays an annual retirement benefit taxable to the employee. The employer can make additional deductible contributions to the plan to purchase life insurance on employees’ lives, to be paid to a designated beneficiary.
BENEFITS AND BURDENS
Even though section 412(i) plans have a guaranteed positive rate of return on investment that shifts the risk from the employer/employee to an insurance company, the guaranteed returns are relatively low. The trade-off is elimination of the risk of even lower returns (and possible loss of principal) from investing in the markets.
An advantage to section 412(i) plans is the cost savings employers receive due to the administrative ease of calculating annual contribution amounts. Contributions are calculated using a simple present-value formula based on the guaranteed rate of return, the retirement benefit and the number of years until the employee’s retirement. This eliminates actuarial expenses to calculate yearly contributions.
WHO SHOULD INVEST?
Owners of high-earning, stable businesses who want to contribute substantial deductible amounts to their retirement plans will most likely benefit from section 412(i) plans. To achieve the maximum tax benefits, business owners usually should be 50 or older. Because the nondiscrimination, participation and vesting rules typical to retirement plans also apply to section 412(i) plans, businesses with fewer than 10 employees benefit most. (As the number of employees increases, the total cost of contributions rises and the business owner’s retirement goals are potentially hindered.)
CONCLUSION
The recent popularity of section 412(i) plans is forcing many CPAs to learn more about a provision they hardly ever considered previously. Section 412(i) plans may allow some clients to achieve their retirement goals, while significantly leveraging the deductibility of their contributions and reducing their investment risk. However, such plans are not for everyone. Thus, CPAs should become familiar with these plans to determine whether they suit their clients.
For more information, see the Tax Clinic, edited by Frank O’Connell, in the September 2003 issue of The Tax Adviser.
—Lesli Laffie, editor
The Tax Adviser (click here)
From The Tax Adviser:
The Section 412(i) Retirement Alternative
Recent stock market declines have triggered substantial losses for many retirement plans, leading clients to rethink investment strategies and life insurance companies to tout IRC section 412(i) plans as a way to protect retirement funds. CPAs should review such plans to advise eligible clients.
HOW DO THEY WORK?
Section 412(i) plans are defined benefit pension plans guaranteed exclusively by annuity contracts and life insurance. (Defined benefit plans pay definitely determinable benefits to an employee over a period of years—usually for life—after retirement.) Section 412(i) plans have been around since 1974; in uncertain markets, their guaranteed returns are enticing.
An employer funds such a plan by making annual deductible contributions for eligible workers; the employees are not taxed on the contributions. The plan then purchases from an insurance company annuity contracts with a guaranteed return (generally ranging from 3% to 5%). When a worker retires, the annuity pays an annual retirement benefit taxable to the employee. The employer can make additional deductible contributions to the plan to purchase life insurance on employees’ lives, to be paid to a designated beneficiary.
BENEFITS AND BURDENS
Even though section 412(i) plans have a guaranteed positive rate of return on investment that shifts the risk from the employer/employee to an insurance company, the guaranteed returns are relatively low. The trade-off is elimination of the risk of even lower returns (and possible loss of principal) from investing in the markets.
An advantage to section 412(i) plans is the cost savings employers receive due to the administrative ease of calculating annual contribution amounts. Contributions are calculated using a simple present-value formula based on the guaranteed rate of return, the retirement benefit and the number of years until the employee’s retirement. This eliminates actuarial expenses to calculate yearly contributions.
WHO SHOULD INVEST?
Owners of high-earning, stable businesses who want to contribute substantial deductible amounts to their retirement plans will most likely benefit from section 412(i) plans. To achieve the maximum tax benefits, business owners usually should be 50 or older. Because the nondiscrimination, participation and vesting rules typical to retirement plans also apply to section 412(i) plans, businesses with fewer than 10 employees benefit most. (As the number of employees increases, the total cost of contributions rises and the business owner’s retirement goals are potentially hindered.)
CONCLUSION
The recent popularity of section 412(i) plans is forcing many CPAs to learn more about a provision they hardly ever considered previously. Section 412(i) plans may allow some clients to achieve their retirement goals, while significantly leveraging the deductibility of their contributions and reducing their investment risk. However, such plans are not for everyone. Thus, CPAs should become familiar with these plans to determine whether they suit their clients.
For more information, see the Tax Clinic, edited by Frank O’Connell, in the September 2003 issue of The Tax Adviser.
—Lesli Laffie, editor
The Tax Adviser (click here)
Thursday, May 13, 2004
A Parent's Game Plan For College Funding
Most people look back on their college years with great fondness - and many look ahead to their children's education with some fear. With costs so high, how can I afford to send my kids to college? According to the 1998-1999 College Board numbers, a college education currently averages $40,000 for a four-year degree at a public college, and nearly $85,000 of a four-year private school. Looking at the Ivy League? Four years of tuition, fees, and room and board now costs about $127,000 at elite schools like Harvard and Yale. And costs keep rising. The College Board's 1998-1999 figures show that public and private institutions raised their tuition and fees an average of 4.5%, while room and board charges increased 4%.
Your children deserve the enriching experience of higher education, and you can help finance it. Here are some college funding ideas:
Prepay Tuition - Some state universities have set up innovative programs where college expenses may be made in installments over many years, prior to attending the school. This may be a convenient way to meet expenses, but it takes the choice of school away from your child. What if your child does not want to attend a state university? This could pose a problem.
Borrowing - These days, most people borrow at least a portion of the money needed to cover college expense. You'll want your children to look for student loons with special lower rates and repayment terms for college. However, repaying a large loan for many years after graduation can be a burden for recent graduates. Tapping into your 401(k) plan may be an option, but you'll want to take a loan rather than a withdrawal to avoid tax consequences. Of course, a loan will impede the potential growth of your retirement nest egg.
Financial Aid - There ore billions of dollars available each year in scholarships, grants, and work study programs. Financial aid to middle income families may be tough to come by, but it's worth contacting your child's high school and prospective college financial aid offices to see if you're eligible.
Educational IRA's - In 1997 Congress created a new type of saving vehicle specially designed for educational savings. This vehicle is called an Educational IRA. Up to $500 (depending one's income) can be contributed each year for each child. Although the contributions are not tax deductible, this money will grow on a tax-deferred basis, and can be used for "qualified higher educational expenses" incurred prior to age 30. Distributions used to pay qualified education expenses are excludable from income taxes.
Additionally, it should be noted that distributions from traditional and Roth IRAs that are used to pay "qualified higher education expenses" of the taxpayer, his or her spouse, children or grandchildren are not subject to the IRS 10% penalty imposed on premature distributions (before age 59 1/2).
The Team Approach - With the seemingly overwhelming cost, it may be most practical to finance college through many sources - your personal savings, student loans, financial aid, even a part-time job for your child. Once in school, your child might want to look into paid internships that provide valuable experience and help pay the bills. Every bit will help, but the bulk may still have to come from money you put away over the years - so it's essential to make the most of your savings and investments.
Start Saving Now - There's no better time than the present to begin accumulating funds for future college costs. Below are some tips:
Time is On Your Side - If your children are young, or you don't have children yet, you can put the power of time to work for you. The sooner you start, the better, letting the wonder of compound interest help build a nice fund.
Pay Yourself First - Systematically invest at a regular interval an amount you can comfortably afford. You can have this done automatically through bank drafting and payroll deduction. Speak to your financial institution and payroll department to set up these convenient savings methods.
Use Tax Advantages - You can try to maximize earnings and minimize taxes through several tax-advantaged strategies. Investing in tax-free municipal bonds or bond funds, setting up a trust, and making a gift under the Uniform Gift to Minors Act, or investing in Educational IRAs are three ways to possibly lower the tax bite. Consult your tax advisor and attorney regarding these approaches.
Don't Put All Your Eggs In One Basket - Diversification is a key to reducing potential risk. Dividing your money among different financial vehicles can help protect against loss and increase the potential for competitive returns. If your children are still in diapers and you have a long time horizon, you may want to consider a variety of financial products to complement traditional bank products.
Your children's future is important to you. Attending college can be one of the most rewarding times of their life. Ensure that your children will have that opportunity to learn, to grow, to graduate from a fine university. Start accumulating funds today and one day you'll stand proud at their graduation ceremony.
Your children deserve the enriching experience of higher education, and you can help finance it. Here are some college funding ideas:
Prepay Tuition - Some state universities have set up innovative programs where college expenses may be made in installments over many years, prior to attending the school. This may be a convenient way to meet expenses, but it takes the choice of school away from your child. What if your child does not want to attend a state university? This could pose a problem.
Borrowing - These days, most people borrow at least a portion of the money needed to cover college expense. You'll want your children to look for student loons with special lower rates and repayment terms for college. However, repaying a large loan for many years after graduation can be a burden for recent graduates. Tapping into your 401(k) plan may be an option, but you'll want to take a loan rather than a withdrawal to avoid tax consequences. Of course, a loan will impede the potential growth of your retirement nest egg.
Financial Aid - There ore billions of dollars available each year in scholarships, grants, and work study programs. Financial aid to middle income families may be tough to come by, but it's worth contacting your child's high school and prospective college financial aid offices to see if you're eligible.
Educational IRA's - In 1997 Congress created a new type of saving vehicle specially designed for educational savings. This vehicle is called an Educational IRA. Up to $500 (depending one's income) can be contributed each year for each child. Although the contributions are not tax deductible, this money will grow on a tax-deferred basis, and can be used for "qualified higher educational expenses" incurred prior to age 30. Distributions used to pay qualified education expenses are excludable from income taxes.
Additionally, it should be noted that distributions from traditional and Roth IRAs that are used to pay "qualified higher education expenses" of the taxpayer, his or her spouse, children or grandchildren are not subject to the IRS 10% penalty imposed on premature distributions (before age 59 1/2).
The Team Approach - With the seemingly overwhelming cost, it may be most practical to finance college through many sources - your personal savings, student loans, financial aid, even a part-time job for your child. Once in school, your child might want to look into paid internships that provide valuable experience and help pay the bills. Every bit will help, but the bulk may still have to come from money you put away over the years - so it's essential to make the most of your savings and investments.
Start Saving Now - There's no better time than the present to begin accumulating funds for future college costs. Below are some tips:
Time is On Your Side - If your children are young, or you don't have children yet, you can put the power of time to work for you. The sooner you start, the better, letting the wonder of compound interest help build a nice fund.
Pay Yourself First - Systematically invest at a regular interval an amount you can comfortably afford. You can have this done automatically through bank drafting and payroll deduction. Speak to your financial institution and payroll department to set up these convenient savings methods.
Use Tax Advantages - You can try to maximize earnings and minimize taxes through several tax-advantaged strategies. Investing in tax-free municipal bonds or bond funds, setting up a trust, and making a gift under the Uniform Gift to Minors Act, or investing in Educational IRAs are three ways to possibly lower the tax bite. Consult your tax advisor and attorney regarding these approaches.
Don't Put All Your Eggs In One Basket - Diversification is a key to reducing potential risk. Dividing your money among different financial vehicles can help protect against loss and increase the potential for competitive returns. If your children are still in diapers and you have a long time horizon, you may want to consider a variety of financial products to complement traditional bank products.
Your children's future is important to you. Attending college can be one of the most rewarding times of their life. Ensure that your children will have that opportunity to learn, to grow, to graduate from a fine university. Start accumulating funds today and one day you'll stand proud at their graduation ceremony.
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