Information Provided Courtesy of WMi
© 2005 WEALTH MANAGEMENT INTERNATIONAL, INC.
- THE TRUTH ABOUT LIFE INSURANCE AND ANNUITIES -
A M u l t i - T r i l l i o n D o l l a r I n d u s t r y o f D e c e p t i o n
C R E A T E D J A N U A R Y 2 0 0 5
All roads lead to insurance and annuities. At least that’s what you may have been or will be told by many insurance salespeople, financial planners, and insurance companies. The reality is that all insurance is a carefully calculated bet between you and the insurer; like gambling in Las Vegas, the house comes out ahead. The idea that wealth is best accumulated and preserved through insurance products is simply untrue. You should obtain a detailed analysis for any policy you own or those you are considering to determine how you will benefit from the policy (after taxes) as compared to other options. This analysis should be from an independent, unbiased qualified source. WMi clients receive such analyses as a standard part of our services. Don’t be taken…
Although life insurance can play an important and valuable role in life, a balanced, objective discussion is hard to come by — the specialists are mostly the salespeople, financial planners, and others who earn their living from high commissions. You may have read articles or seemingly authoritative books suggesting life insurance and annuities are the answer to most every financial planning objective — from meeting retirement needs to paying estate taxes. Curiously, the authors either sell those products or are aligned with someone who does and receives kick-backs. Therefore, their advice is biased. Conventional wisdom is often wrong. The problem stems from undisclosed details about:
High commissions
Loss of investment control
Loss of preferential tax rates (annuities)
Potential IRS challenges of certain arrangements
Limited availability of risk management and tax planning strategies.
LIFE INSURANCE
Cash Value Life Insurance Commissions: 50% – 100%+ of first-year premium, 3% – 10% on renewal premiums for most policies
Surrender Charges: 10 – 20 policy years
IRS Penalty: 10% for withdrawals before age 59 ½ (certain loans exempt.)
Rate of Return on Death Benefit and Cash Value
Regardless of the type (term or permanent), a life insurance policy is simply a contract granting substantial benefits to your beneficiaries — far greater than your premiums plus interest — if you die prematurely. But if you live to or beyond life expectancy, it’s the insurer who comes out ahead, with cumulative premiums plus what they earned on them over the years being far greater than the death benefit. Specifically, the insurer pays only a fraction of the money’s value (typically 3.5% – 5%) and pockets the difference (the spread) — usually several percent more over the years. At best, you should view the policy as a long-term, low-yield, low-risk asset. You may be able to achieve higher returns while carrying a low-cost term policy to insure against premature death. This will be clear in a side-by-side comparison of a term policy and properly managed separate investment account or on an Internal Rate of Return (IRR) policy illustration from the insurer.
Getting Income from the Policy — the Tax-Free Loan Scheme/Trap
The internal gross rate of return on premiums, after policy expenses, is a negative (loss) for the first several policy years (usually for the first 8 to 12). The rate then typically increases gradually each policy year, maxing out at 3% – 5.5% if the policy is adequately funded and all sales loads are recovered (based on current, non-guaranteed assumptions; based on policy guarantees, returns are far less). Furthermore, it can take 20 years or longer to reach this lack-lustre, non-guaranteed rate.
Even your best case — the 5.5% return — has an additional caveat: While you may take tax-free loans from the policy, you can never actually access all of your money in this way. If you do, the policy will lapse, making the entire amount of the policy’s prior gain subject to ordinary income tax in the year of lapse. So, to avoid this trap, you must leave on deposit with the insurer enough of your cash value to sustain the policy to your death — in essence, a form of "insurance tax." The remaining death benefit of course is of value… just not to you. The required deposit can be substantial — 20% or more of your cash value — effectively further reducing your return on investment. It gets worse: If the policy allows for an increase in insurance costs, or higher interest than when you originally structured the loan, you may have to return money to the insurer, or suffer the potentially devastating economic effects of the policy’s lapse.
Conclusion: Life insurance is generally not an attractive investment. Much can and does go awry, and it should be used only to meet the need of managing risk. Only policies with a low cost for providing the desired death benefits should be used. WMi can help you make these decisions and evaluate policies disclosing the costs and economic comparisons to alternatives.
Term Life Insurance
This type of insurance is simple and straight forward. You choose the amount of coverage and the policy term, or number of years the policy is guaranteed to remain at a level premium. Term insurance and certain universal life policies with low premiums and long-term death benefit guarantees are usually the best deal. They can be designed to meet any insurance need at the lowest cost.
ANNUITIES
* Commissions: 3% – 12% of premium* Surrender Charges : up to 8% for policy years 1 through as many as 10
* IRS Penalty: 10% for withdrawals before age 59 ½ While there are many types of annuities, they fall into 3 basic classes: fixed, variable, and immediate. Annuities are taxed under special rules that insurers and salespeople tend not to explain adequately. Although interest or gains in annuities are tax deferred, this deferral can come at a high cost — after expenses and taxes, any economic benefit to you may be erased for reasons described below:
Fixed Annuities These interest-bearing contracts are similar to a certificate of deposit (CD), with crediting rates set by the insurer annually and not tied to any index. Because of this, the rate of return you actually earn on your money doesn’t correlate to what you receive. You’re at the insurer’s mercy, and can only hope to get a fair rate. Be sure to compare the insurer’s crediting rate history to investments with similar risks and time commitments to see how they’ve treated policyholders in the past.
What they earn and what they pay – Naturally, the insurer has issued the contract seeking a profit. So if they earn 8%, for example, on your money in a given year, they’re required to pay you only the minimum guaranteed rate — typically 3%. While it is in the insurer’s interest to keep your money for as long as possible, in good economic times they will pay higher than the minimum to keep you invested. Over time, we have commonly seen policy’s earn a below-market rate of return. A side-by-side comparison of an annuity earning say 6.5% to a separate "ordinary" account earning the full 8% return under this example will show the purported tax benefits are of little to no value (depending on time and your tax rate) as you may not come out ahead after tax.
Variable and Equity Indexed Annuities
Comparable to investing in mutual funds, these annuities can be costly mistakes as a result of very high commissions, ongoing fees, and horrendous, inflexible tax treatment. Because capital gains and dividends on annuities are taxed as ordinary income, you lose the lower tax rates (as of the publishing of this document 11-1-2004) currently max. 15% vs. 35% max. for ordinary income). All gains are taxed under last in/first out (LIFO) rules — gains are deemed withdrawn first and are fully taxed as ordinary income – results in more tax being paid sooner upon withdrawal. High insurance (mortality) charges ranging from .75% – 2.5% annually — for an expensive to illusory benefit for most policies at best — further cut into your return.
Redeeming products in this group are Equity-Indexed Annuities and certain step-up guaranteed policies. While they have the same unfavourable tax treatment and high fees, they allow you to participate in some of the upside of the market while being guaranteed against loss and provide a minimum return during market declines. The guarantees can be very costly. If markets do well, your net return will be far less than what you would have had because of the charges and higher taxes.
Immediate Annuities
They are an irrevocable assignment of your money to the insurer in exchange for a lifetime guaranteed income that may be more or less than your money would yield under your control, depending on how long you live and the payout rate used by the insurer. Again, the house (the insurer) is willing to gamble that you will lose. You should consider these products only if your investment style and anticipated life expectancy make it likely that you will benefit. WMi can help you determine this.
A Last Thought on Annuities
All annuities are ineligible for an adjusted stepped-up basis at death (aka income in respect to a decedent, or IRD). This means any amounts left to your heirs over the cost basis (or investment) amounts are taxed as ordinary income. If instead you invested in mutual funds, stocks, real estate, etc., no tax would be due; your heirs would be assumed to have paid the fair market value at your death for the asset. A WMi economic analysis can accurately reveal the advantage or disadvantage of any cash-value life insurance or annuity product. We strongly recommend you obtain the analysis before you buy. Refer to our Life Insurance and Annuity fact sheets for more information and examples.
Privacy Protec t i o n A s s e t Protecti o n Risk Management Insurance Assessment Investment Evaluation Private Banking Taxation Estate-Transfer Charitable Giving Anyone advising you who make more or less money based on your decisions, they have a conflict of interest.
NO CONFLICT — JUST INTEREST™ -
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