The 7 costly mistakes your clients make, Pt. 4: Stockpiling hay for everyone else but themselvesArticle added by Tony Walker on April 18, 2014
Tony Walker

Tony Walker

Bowling Green, KY

Joined: March 11, 2010

This is the third article of a series on costly mistakes your clients make. To read part one, click here, for part two, click here, and for part three, click here.

While many people have a game plan for saving and investing money (the accumulation phase of life), those same folks do not have a game plan for using and enjoying it (the spending phase).

It can happen to any of us: We work and worry ourselves sick about stockpiling more and more hay, and for what? To leave it to someone who’ll probably blow it? There’s nothing wrong with your clients stockpiling money for the future, unless it takes control of their lives and zaps their joy in the process. Moral of the story: At some point, your clients must either decide to spend it on themselves and those whom they care about (family and charity), or they’ll let others spend it for them (the government, Wall Street, banks, their favorite attorney, relatives they never really cared for, nursing home, etc.).

So what’s the goal when it comes to your clients using and enjoying their money? Depending on their ages, there are two financial products that can help your clients gain more control over their money.

Dividend participating whole life

Dividend participating whole life (DPWL), or whole life as it is more commonly referred to, is one of the few (if not only) financial products that provides both tax-free access to cash (for anything we want) during our lifetime and a barn full of tax-free, cold, hard cash for our loved ones when we kick the bucket. While this product is for all ages, it works very well for young folks.

For example, a 23-year-old college graduate lands his first full-time job. To help him save more money, reduce taxes over time and provide himself a source of accessible safe money, he invests $500 a month into his own whole life policy. Below is a whole life policy illustration showing the “non-guaranteed” values based on “current “dividends.”

Dividend participating whole life
(non-guaranteed current dividend scale)

When our college graduate reaches age 65, based on current dividends, his cash value (that’s the money that’s available to him during his lifetime) is $883,743, while the death benefit (the amount of tax-free cash that goes to his loved ones when he kicks the bucket) is $1,774,275. Plus, through a special rider called “waiver of premium for disability,” should our college graduate become totally disabled, the insurance company will continue to pay the $500 a month (for as long as he remains disabled).
The split annuity concept

Here’s another safe idea for your clients to use and enjoy more of their money, which is also very appropriate for folks at or near retirement: the split annuity.

Person A is a typical retiree who has $200,000 in a CD currently earning 3 percent. His or her main objective is to protect principal and live off the interest. This was a good strategy when CDs were paying 5 percent or 6 percent — but 3 percent?

Notice the retiree in the CD strategy receives $6,000 per year. However, Uncle Sam gets to take his fair share in taxes from the $6,000 (here’s where paying taxes on the same dollar more than once comes into play). So let’s say this person is in a 30 percent tax bracket; the IRS takes $1,800 (30 percent of $6,000). This leaves person A with a “net” annual income of only $4,200.

Person B takes the same $200,000, and instead of giving it to the bank, he or she gives it to the insurance company. The insurance company “splits” the money into two separate buckets: One is what’s known as an immediate annuity, and the other a fixed annuity.

With the split annuity, the annual income is $6,765 a year. Plus, based on a favorable provision in the tax law (called an exclusion ratio) our retiree only pays taxes on $202, providing a higher net annual income of $2,505.

But you may ask, “Isn’t Person A draining one of the buckets down to nothing?” Great question. The first bucket under the split annuity strategy pays out more money (principal plus interest) so that the retiree can safely use and enjoy more money (which is the whole point). When the first bucket is completely empty, we simply move over and tap into the second bucket, which, during the period of time that the first bucket is being drained, has grown tax-deferred (no taxes during accumulation). So with the split annuity, your client gets more income, pays less taxes and gets “sleep insurance,” all in one.

As always, be sure to talk to your clients about whole life and the split annuity concept to see which choice is best for them and their situations, and if they’re viable options for their portfolios. You’ll be glad you did, and your clients will most likely worry less about their retirement as a result.
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