Three-dimensional financial planning: Using life insurance and annuities

By Dick Duff

RWD Enterprises

In my last few columns, I stressed the importance of keeping money safeguarded in life insurance, annuities and IRAs/qualified plans (QPs). This is tax and financial asset protection at its best: (a) using legitimate tax avoidance and (b) protecting against loss from waste, divorce, lawsuits and future creditors -- even bankruptcy.

Indeed, if you want to really set yourself apart from other advisors, first become very knowledgeable about laws and strategies that affect life policies, annuities and retirement plans. The key in our business isn't mastering 1035 exchanges; it's always a combination of (a) first-rate products from quality insurers, and (b) wonderful planning possibilities that make use of all that's blessed by the system.

There's always a challenge and a lot to understand. In this column, we'll try a simple strategy that should lead to a bunch of new business.

I. One-dimensional traditional financial thinking:

Let's imagine a mature lady client, Nona. At about age 71, she seems committed to a five-year, $250,000 FDIC-insured certificate of deposit (CD); it pays 2.5 percent -- $6,250 in fully taxed interest or about $510 monthly, discounted at this interest rate. Naturally, she wants her son, Tony, to have this someday. But there are some problems: Her excess FDIC insurance runs out on January 1, 2010. Obviously, there is no upside or inflation protection, and there is a penalty of six months' interest on withdrawals of principal. And, CDs have neither tax advantages nor any state-measured protection from creditors.

What a bad place to put your money. You must come up with a plan. If you don't, Nona and you are wasting an incredible opportunity. Is there something better? Anything?

There is! Nona needs to come to your office where you can shut the door and turn off the cell phone. You will prepare carefully and spend time with her in a purely educational way. She needs to know how to spend her money and how this improves everything for Tony and her. Here's some "sizzle" that will turn a few heads.

II. One-dimensional financial thinking using life insurance

For $250,000, let's say Nona can obtain a $900,000 life policy that will not lapse for 29 years -- until age 100. This works out to these guaranteed, compounded tax-free interest rates of return for Tony: (a) 4.5 percent for death at age 100, (b) 5.75 percent for death at age 95, and 7 percent for death at age 90.

Not bad when you think about it, right? But, this plan benefits only Tony, so Nona probably won't go for it.

III. One-dimensional financial thinking using SPIAs

For $250,000, let's say Nona can obtain monthly SPIA incomes of (a) $1,900; life-only, (b) $1,600 life, plus 240 payments guaranteed; or (c) $1,680, with merely 240 payments guaranteed.

If you run the numbers, these incomes pay out excellent amortized interest rates -- something like (a) 5.75 percent, (b) 4.75 percent, or (c) 5.25 percent -- throughout 20 years of payments. The problem is that Nona will probably point straight to the negatives. These include (1) "I don't understand it," (2) "I'll give up all my money to an insurance carrier," and (3) "Tony will want cash instead of payments" (if any) that will be his. I doubt that she'll want this, either.

Now, here's the strategy that can work:

IV. Three-dimensional financial thinking using life insurance, SPIAs and a "side fund."

Apply the numbers in points II and III around the following model:
    A. If $250,000 buys $900,000 of lapse-proof life insurance, then $68,000 or so buys $250,000 of coverage. (This gives Tony the same death benefit as a $250,000 CD.)

    B. If $250,000 buys a $1,900 monthly life-only SPIA, then $67,000 or so buys a $510 monthly SPIA. (This is what a $250,000 CD @ 2.5 percent will pay Nona.) Further, most of this income is tax-free and gives her significantly more money after taxes than the CD. SPIA cash flow may even be a creditor-protected income stream under her state's law.

    C. Now (from life insurance and a life-only SPIA), Tony and Nona have death benefits and income that replicate those offered by a CD. She also has about $115,000 remaining that can do some remarkable things for her and her son.
For instance, if another $115,000 is spent wisely, it can:
    1. Increase her $510 SPIA life-only monthly income to nearly $1,400 per month.

    2. Broaden a life-only SPIA income to include 20- or 25-year terms certain or installment income features.

    3. Amortize over seven years into some high cash-value life insurance; then someday, she'll take tax-free loans or withdrawals.

    4. Add a cost-of-living (COLA) rider to her SPIA or a long term care benefit to her life policy.

    5. Add both death benefits and annuity income.

    6. Acquire indexed SPDAs that could credit excess interest and offer strong guaranteed lifetime income withdrawals (GLWBs) in a few years. Then, she'll take income with something for Tony as well. (Of course, she could always annuitize this policy instead, given its level exclusion ratio.) She might even add a long term care benefit to this contract.

    7. Purchase a separate long term care policy, with or without cash values.

    8. Buy a CD -- my least favorite option -- for use as an "emergency" fund. (Alternately, her SPIA could become a safety net if it has a right to commute or accelerate payments. Then, if she needs money, the insurer levies a charge and gives her the cash. As she gains an income that she can't outlive, she can also get her money back and control what's left in the contract.)

    9. Let her get "frisky" and choose stocks or a mutual fund and accept some risk.

    10. Allow a mixture of the above.
Surely, you'll think of other possibilities for her remaining capital.

Notice how this three-dimensional planning solves so many financial problems? Nona gets out from a boring $250,000, 2.5 percent CD. With education on how to use life insurance and annuities in retirement income thinking, she gains a mix of more income, tax savings, potential creditor protection certainty -- and much more. You'll also help her build a strong line of credit for emergencies -- just in case. Most importantly, it gives Nona flexibility and options that simple CD instruments don't permit. This is important in a challenging financial environment.

Everything starts with basic financial planning, without much said about products, surrender charges and market value adjustments. (You'll have time for these later.)

In summary, when Nona finally "gets it" and accepts your analysis, she'll surely direct you to (a) another CD she owns, and (b) a few friends whom she'll invite personally to your next seminar. There might also be generous compensation to capture, as well. Just look at what some creative financial thinking will do.

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