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Sneak Peek from the MAD Quarterly: You Bet Your Life (Insurance)

Most of us lost significant money in our investments. We all saw our properties depreciate in value. Nearly all of us are afraid of investing in this volatile market. What do we do?

I had the opportunity to speak with Jason Feldman, financial advisor with the Northwest Mutual Financial Network. Feldman (CLTC, FINRA Series 7, 63, and 66) is a member of the Million Dollar Round Table, and recipient of the prestigious National Quality Award (NQA) for six consecutive years, 2004-2009. More importantly, he specializes in advising owners of multifamily properties on how to invest proceeds from sales or refinancing.

NEIL GRONOWETTER: A lot of people think life insurance is just protection for your loved ones, after you die. How can you characterize life insurance as an investment while you’re still alive?

JASON FELDMAN: The value of a permanent life insurance policy, in addition to the death benefit, is the steady build up of cash value Northwestern Mutual’s consistent, long-term approach can grow significant value with minimal risk. So, while you may also have money in investments that offer more risk, the cash value inside your life insurance provides a safe and solid foundation for your overall long-term saving and investment options. The consistency and reliability of a Northwestern Mutual portfolio-based life insurance policy gives our policy owners a tremendous level of support. They can use their cash value for “living benefits” such as:

• Retirement Income – When you retire, you may need more income than you pension plan, 401(k) or Social Security can provide. You can use the cash values in your portfolio-based life insurance policy to supplement your retirement income.
• College Tuition – The cash value your policy generates as your child is growing can be used to help pay college tuition bills.
• Opportunity Dollars – You can use the cash values to help make the down payment on a new house, provide startup cash for a new business or take advantage of other opportunities as they arise.

NG: How can you structure a life insurance policy so that you derive income from it while you’re still alive?

JF: You can overfund a policy. You put additional discretionary premium above what is required. This way, the policy grows equity much faster and there is a lower overall insurance cost per total premium that you fund into it. After about 20+ years of funding, the owner of the policy can then systematically borrow from the policy cash value tax-free as a self-directed tax-free income stream.

NG: What are the income tax ramifications of such a product?

JF: The death benefit is income tax-free and can be estate taxable only if the total estate value including the death benefit owned outside an irrevocable trust is beyond the lifetime exemption which is currently $3.5 million per spouse. The cash value accumulation in the product is tax-deferred. All policy loans are tax free. Any cash surrender is taxable as ordinary income beyond the premium cost basis. If the contract is later converted to an annuity, the income is tax as ordinary income beyond the cost basis according to the exclusion ratio. All dividends are tax-free except for dividends paid out in cash to the owner beyond the premium cost basis.

NG: In these volatile economic times, why might life insurance be an even more crucial component of a retirement strategy? How did life insurance (companies) fare during the Great Depression?

JF: The primary function of permanent life insurance is a guaranteed death benefit; however, one should not overlook the lifetime benefits that policy cash values can provide. One of the major advantages to this involves the use of life insurance to supplement retirement income. Why life insurance? The primary reason lies in the income tax advantage it holds over other vehicles under current tax law. Cash accumulation in the policy is tax-deferred.

Unlike many other assets, income tax is not assessed annually on values within an insurance contract. When retirement arrives, the flexibility of life insurance and its special tax treatment compare favorably with other assets. For example, those who still need insurance when they retire can exercise a policy option allowing the policy owner to use accrued cash values to pay for a defined death benefit for a limited number of years, without having to make any additional premium payments. Alternatively, the policy owner has the right to convert the policy to a permanent policy with reduced death benefits, while keeping the cash value intact. Under either scenario the policy owner owes no future premiums or income tax, which frees up cash flow to be spent on retirement activities. Perhaps the most popular course, however, is the payment of part or all of the premium by the policy dividends, which avoids reducing either the period or amount of coverage.

Those whose insurance needs have changed and no longer require death benefit protection at retirement have more options still:

First, the policy can be converted to an annuity, without triggering immediate tax on policy gains. Instead, tax is generally owed on part of each payment as it is received. No other product or asset offers this feature.

Second, the policy owner can make tax free cash withdrawals for the policy to supplement other sources of retirement income. Under current tax law, surrenders and withdrawals generally are not taxed until the exceed the policy’s cost basis. If the policy is structured for this use, policy loans are never taxed unless the policy is surrendered before the insured’s death.

When added to a company pension, social security, and personal savings, permanent life insurance can offer unmatched flexibility as a source of supplemental retirement income.

NG: Suppose a 55 year-old man sold his apartment building for $1,500,000. Please illustrate what he can do with his money right away, minimizing tax exposure, and maximizing his rate of return.

JF: Here, a fixed annuity or some sort of variable annuity with a guaranteed minimum rate of return would make more sense than permanent insurance due to age and how the insurance product must be fund over at least 4-5 years. If he or she is looking to shelter assets against estate taxes, than a permanent insurance vehicle such as guaranteed universal life contract owned in an irrevocable trust would make sense in conjunction with the investments.

Also, if he or she is a sole proprietor or other type of business owner, a defined benefit plan can be established that can create significant tax deduction but typically the maximum contribution per year is 100% of income.

NG: Suppose a 40 year-old man refinanced an apartment building, and has $750,000 cash.  Please illustrate what he can do with his money right away, with an eye toward minimizing tax exposure, and maximizing his rate of return.

JF: For a business owner, or sole-proprietor, a SEP IRA is a good source of tax-deduction if there is business income of at least $100,000, especially if he has few employees that have been working for him for more than 2 years.  To maximize rate of return, a well diversified mutual fund portfolio would make sense for the underlying investments.

Whole life insurance will not maximize return but will minimize risk and create a vehicle for tax-deferred growth and tax free access to cash values.

NG: Bear Stearns, Lehman Brothers, and AIG died in 2008. Citibank and GM may not be too far behind. If AIG went broke, what’s to stop your insurance company (Northwest Mutual) from going the same route?

JF: Four words: No debt. Record surplus.

I’ll defer to Northwestern Mutual’s President and CEO Edward Zore to expand:

“Northwestern Mutual entered 2008 with a near-record level of surplus. Nearly three-quarters of our total insurance premium revenues is generated by the company’s large block of whole life insurance, considered the most stable and lowest risk type of product in the industry. We do not make aggressive guarantees, either with universal life insurance or variable annuities. We have no debt on our balance sheet. By every measure Northwestern Mutual remains very sound financially.”