Another premium financed life insurance program to avoid
By Roccy Defrancesco
The Wealth Preservation Institute
The Webinar I attended last week was on a premium financed life (PFL) structure done for the sole purpose of generating a tax-free retirement income stream (not for death-benefit planning). Below are the sales pitch and my breakdown of the math, so you can determine if you want to stay away from this program.
An example is the best way to illustrate how the program might work for one of your clients. Assume the client is 41 years old when the plan is funded, and that he borrows money tax free from the life policy from ages 66-80. Assume the money grew on average in the EIUL policy at 8 percent a year during the life of the plan (their assumptions).
1) Client borrows $1 million... to pour into an EIUL policy throughout five years. The policy is the primary collateral, with a personal guarantee being the secondary collateral.
2) Interest rate is either LIBOR or prime. There appears to be a margin in the loan of approximately 2.25 percent. The interest rate based on prime was quoted in the Webinar at 5.5 percent (prime is currently 3.25 percent). The interest rates floats yearly, meaning it's not locked.
3) Client pays interest only on the loan: $55,000 a year in non-deductible interest if we assume a 5.5 percent for the life of the loan (which is a joke, but let's go with it).
4) When the client turns 66, he pays back the loan from the life policy's cash value and borrows $268,000 tax free from the policy every year for 15 years (total borrowing $4,020,000).
Sounds great, right? Where do you sign up to sell this wonderful plan? Don't you want to know if it makes financial sense to do this? Don't you want to see real-world numbers, so you can make the determination?
Using this PFL plan vs. two other options
As always, I want to know what would happen if the client didn't do this plan and instead did something else.
Something else No. 1: Funding a tax-deferred qualified plan (profit-sharing/defined-benefit combo plan). If the client tax deducted money into a defined benefit plan instead of paying the $55,000 a year non-deductible interest payment (which is slightly less than that for the first four years as the loan rolls up), how would it compare?
If we assume the client is in the 35 percent income tax bracket, he could tax defer $84,615 a year into such a plan ($55,000/.65 = $84,615). If the money grew at a gross 8 percent a year (and I netted the return down to 6.8 percent a year because I assumed a 1.2 percent mutual fund expense), the client could remove $480,323 pre-tax in retirement from the tax-deferred plan, or $312,210 after tax each year.
That's odd. $312,210 is much more than the $268,000 from the premium financed life program.
Something else No. 2: Take the money spent on interest for the PFL program and, instead, fund it into a Retirement Life(TM) policy. I used the conservative Retirement Life(TM) policy with a 7.5 percent rate of return and a 7.5 percent policy loan interest rate (no positive arbitrage on the loan) and guess how much could be borrowed from the policy each year starting at age 66? $392,540 each year for the same 15-year period.
Let's compare the annual after-tax/tax-free income from the three above wealth-building options from the client's age 66-80.
|Premium Financed Life Program||$268,000||(Total tax free income = $4,020,000)|
|Tax Deferred Qualified Plan||$312,210||(Total tax free income = $4,683,150)|
|Retirement Life(TM) funded after tax||$392,540||(Total tax free income = $5,888,500)|
Don't believe the numbers? I took the $268,000 number right off the PowerPoint slide from the Webinar.
Conclusion No. 1
Using the premium finance program as illustrated during last week's Webinar sure doesn't seem to work, even if a "trusted advisor" told you.
A 5.5 percent loan rate for 25 years is a joke
The lending rate used during the Webinar for the borrowed funds was 5.5 percent. The rate is tied to the Prime rate (currently 3.25 percent), which means the margin on the loan is 2.25 percent. The following chart shows the last 50-year history of the prime rate plus a 2.25 percent margin. The red line is the 5.5 percent rate that was projected forward 25 years in the premium financed life program. The illustration from the Webinar used today's historically low rates on a loan in a program where the interest rate is not fixed. FYI, the average prime interest rate over the last 50 years with a 2.25 percent margin is 10 percent, nearly double the assumption for the plan illustrated during the Webinar.
In my opinion, the interest rate used for the illustration during the Webinar was anything but conservative or real world, and notwithstanding that fact, the program still did not perform well.
Conclusion No. 2
This article should serve as a reminder and warning to everyone in this industry not to take at face value what anyone (including me) says about the numbers when it comes to using sales techniques like PFL insurance or other structures, not even if a "trusted source" endorsed the Webinar. Make sure you run your own numbers and think critically when deciding who you should trust.
One last question to ponder
If you've read work in the past, you'll know that you can sometimes properly build wealth using borrowed funds. Why didn't this plan work with a 5.5 percent interest rate? The answer is because the life policy used was not a good cash accumulator. The promoters used one of my least favorite EIUL policies in the marketplace.
Finally, and not surprisingly, the commission using this not-client-friendly PFL program is nearly triple the commission vs. just taking the money spent on the interest payments and funding Retirement Life(TM).
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