Modified Endownment Contracts in Life Insurance

May 1st, 2010

contract1 Modified Endownment Contracts in Life InsuranceMEC. The dreaded acronym. When you’re the owner of a tax advantaged whole life insurance policy you’ve probably heard of this acronym. It stands for Modified Endowment Contract. When a life insurance policy becomes a MEC it can have severe tax implications. Properly funding a cash accumulating life insurance policy is pertinent. And knowing the MEC basics is important whether your policy is designed to be used for isnurance protection, retirement, investing, business, estate purposes or a mixture of the above. 

TAMRA & DEFRA are the legal acts that define how life insurance policies can be funded and taxed but they are regulated under section 7702A of the IRC. If a policy does become a MEC then many of the tax benefits are lost. The distributions are treated as income to the extent of the gain and they may incur a 10% penalty.

“Section 7702A defines a modified endowment contract (MEC) as a contract that meets the requirement of § 7702 but fails to meet the 7-pay test of § 7702A(b), or that is received in exchange for a contract that is a MEC. Under § 7702A(b), a contract fails to meet the 7-pay test if the accumulated amount paid under the contract at any time during the first seven contract years exceeds the sum of the net level premiums that would have been paid on or before that time if the contract provided for paid-up future benefits after the payment of seven level annual premiums.” More on this excerpt can be found here.

So what is the 7-pay test and how do we prevent the life insurance policy from becomng a MEC? The 7-pay test requires that the accumulated values do not exceed the sum of the premiums paid over that 7 years…or what would have been paid in premiums over that 7 years had they been paid annually.

Different insurers have come up with different solutions. Some require premiums to be paid every year for the first 7 years. Others use term insurance to boost the death benefit and reduce the number of premiums. The bottom line is that you want to get as close to the MEC limit as possible without exceeding it.  I’ve found this article to be extremely helpful in understanding the nuances of modified endowment contracts. I hope you do too.

Here’s to a MEC-free policy and all the tax benefits that come with it!

Scott Storace (775) 781-5464

Posted in Business Planning, Estate Planning, Financial Strategy, Insurance Protection, Investment Planning, Retirement Planning, Whole Life Insurance | No Comments »

Tax-Free Dividends with Participating Whole Life Insurance

April 18th, 2010

April 15 150x150 Tax Free Dividends with Participating Whole Life InsuranceWhat is a dividend? The simple answer is that it’s a return of premium. The Internal Revenue Code defines a dividend as the return of that portion of the premium that was not used to guarantee the cash values and death benefit of the policy. Therefore, generally speaking, the higher the policy’s premium the greater the annual dividend. But there are other factors that determine the size of the annual dividend.

1)      Interest Earned – The company invests the pool of funds across a variety of conservative financial products. They mainly invest in a diverse group of bonds. The interest that these investments earn is one factor that determines the performance of the company and the available dividend.

2)      Mortality Experience – The company has obligations to pay when a policyholder passes away. The amount of death benefit that gets paid out in a given year will also affect the performance of the company and the available dividend.

3)      Expense Level – The company has expenses. They have the bricks and mortar, salaries, and all other operating expenses.

Factoring together the total cost and the total performance of the company will dictate the annual dividend that the company declares.

Direct Recognition companies recognize when a policy has a loan and credits a different dividend for all loan values in a policy. Typically this dividend is lower than the dividend that is authorized for a policy without any loans. This can have a significantly negative impact on cash flows and effectively punishes policyholders who need the excess to build up cash values.

Non-direct recognition companies issue the same dividend to policyholders regardless of their outstanding loans. Loan or no loan, the dividend is equal. Therefore it’s important to know which type of company your policy is with and how they will credit your dividends.

Looking for a tax-free dividend? Call or email me. (775) 781-5464 or Scott@TheBankingSecret.com

Scott Storace

Tags: Dividend, investing, life insurance, tax benefits, tax-free, whole life
Posted in Estate Planning, Financial Advice, Financial Strategy, Infinite Banking System, Insurance Protection, Investment Planning, Whole Life Insurance | No Comments »

Why Buy Paid-Up Additions?

April 13th, 2010

j0442286 150x150 Why Buy Paid Up Additions?People often ask me what paid up additions are. When structuring our policies we usually place a large amount of each premium towards the purchase of level paid up additions. These premiums are in addition to the base premium. Why do we do this? What’s the benefit to the policyholder?

Paid up additions are small blocks of paid up death benefit. It’s life insurance that you own free and clear. The additional premiums that are used to buy the LPUA’s also increase the guaranteed cash values because the bulk of the earnings premium, less a small up-front expense, becomes immediate cash value. These values are available for your use right away. Another benefit of level paid up additions is that they are dividend eligible. This means that the more LPUA’s you buy, the greater the potential dividend.

By purchasing LPUA’s we are creating a system for annual cash growth within the policy. The paid up additions buy more death benefit and cash value which increase the dividends. The dividends go towards buying more LPUA’s the following year and the cycle repeats. This system helps streamline the growth of the policy values for years to come.

This is especially important for those who subscribe to the infinite banking concept. By gearing the policy towards maximum cash values and maximum cash accumulation we can front load the cash that’s immediately available for your use.

To find out if your policy is properly structured to maximize cash values and cash accumulation, call me or email me. (775) 781-5464 or Scott@TheBankingSecret.com

Scott Storace

Tags: cash value, infinite banking, life insurance, whole life
Posted in Infinite Banking System, Whole Life Insurance | No Comments »

0% Financing with Whole Life Insurance

March 29th, 2010

zero percent 0% Financing with Whole Life InsuranceThese days 0% financing seems to be offered very regularly on vehicles, furniture and electronics. But wouldn’t it be great if you always had access to a pool of funds with no interest expense? When you borrow from specific whole life insurance plans you can. The key is to find a non-direct recognition life insurance company.

Direct recognition companies pay dividends on the policy’s available death benefit and cash value. When you take out a policy loan these values drop. Other companies, the non-direct recognition kind, pay dividends on your death benefit and cash values as if no loans have ever been taken. The money is taken from another account, the general fund, and an IOU is essentially placed on your account. Since your policy remains intact the company will pay you the full dividend.

This is very important. Who wouldn’t want to be paid on money that they had taken out of an account? I would venture to say NO ONE! When you withdraw money from a CD, money market or mutual fund do they continue to pay you? Absolutely not!

When you take a policy loan, that loan is subject to interest charges. Why? You must pay the company back in order for them to maintain the guarantees they made in their contract with you. Counteracting the interest charges is the guaranteed interest income that the company is paying you. Typically this is 4-5%. Add your dividends to the guaranteed interest income and if they equal the interest rate charged then you effectively have 0% financing. This is also referred to as a wash loan.

When dividends and interest exceed the interest charged then your cash values will actually grow.

Where can you find 0% financing…even 1% financing…where you get to choose the terms and approve the loan? The answer: A properly placed whole insurance policy. You’re not limited to buying a specific product from a specific retailer. Since you control the funds and get first access to the cash values, you decide what to finance. The key is finding a strong insurance company that is non-direct recognition. I know a few!

Scott Storace

Tags: cash value, guarantee, life insurance, whole life
Posted in Business Planning, Financial Strategy, Whole Life Insurance | No Comments »

Is Your Ship Sinking?

March 18th, 2010

Sinking Ship Is Your Ship Sinking?With 25-35% paid in taxes and another 25-30% paid in interest expense, your ship might be sinking. At best, the burden of these expenses is keeping it from moving very quickly. Taxes and interest expenses are the 2 biggest holes in anyone’s ship. The average American loses 60% of their income to taxes and interest. Let me ask you this: How big are your holes?

Think of a bucket with holes in it. You can pour water in but it drains right back out. This is a metaphor for our financial lives. We are constantly throwing money in our buckets trying to fill them up, only to have it leak back out through a variety of expenses. The sad thing is that we have been trained taught and educated to believe that this is the way it is or it’s a normal cost of business. Well, it doesn’t have to be. Plug some of those holes and your bucket will fill up faster…without having to add more income or take on more risk.

How much did you spend in 2009 in:

  1. Income Tax :   Federal, State and Local
  2. Sales Tax:   6-8% average on most purchases
  3. Mortgage Interest including Home Equity Loans: Typically 90% in the beginning of the loan and 52% over the life of the loan. Look at your Truth in Lending Statement.
  4. 4.       Automobile Interest Expense
  5. 5.       Credit Card Interest Expense: Typically 12-18%
  6. Finance Fees: Such as refinancing or purchasing a property
  7. 7.       Bank Fees, Investment Transaction Fees, Management Fees:

I challenge you to find out how much you spent in these areas. It will stagger you. And until you understand where your money is going you won’t know which holes need to be plugged.

The Infinite Banking Concept is geared toward plugging these holes. To do this we use a properly structured, tax-advantaged whole life insurance policy. By funding a policy and then using it as your first means of financing it allows you to recapture the interest expense you would have paid elsewhere.

We have been taught to get our loans from the bank. And in some cases we need to. But by building your own system of banking you can reduce and potentially eliminate your dependence upon traditional banking institutions for financing. By borrowing from yourself and paying yourself back, the interest expense goes back to you. In addition we can eliminate loan finance charges and transaction fees.

Take the challenge and identify where your money is truly going. Or contact me and I’ll do it with you. You’ll be amazed!

Scott Storace

Posted in Infinite Banking System | No Comments »

Treasure Found: The Living Benefits of a Death Benefit

March 13th, 2010

treasure Treasure Found: The Living Benefits of a Death BenefitHow can you use a life insurance death benefit while you’re still alive? If you’re guaranteed to receive it, you can. It’s like finding buried treasure. The chest that you’ve been filling yet storing away can be opened and used.

The death benefit that is provided by whole life insurance is guaranteed to pay out as long as you maintain the policy. It’s a guaranteed asset the moment the policy is opened, or in-force. Think about that for a minute. You did not save additional money nor did you invest better and receive a higher rate of return. You added no risk yet upon your death your beneficiaries will receive the proceeds of your death benefit…guaranteed. This is not offered by any otehr financial vehicles except annuities and other forms of life insurance. However, it is unlikely that you will receive a death beenfit with term insurance. Since premiums get astronomically expensive during the latter years of life, most are either converted or dropped. In fact, only 1% of term policies ever pay a death benefit. Therefore, this discussion will be centered around whole life insurance.

The death benefit can become an instant legacy or inheritance left to younger generations. Businesses use the guaranteed proceeds to recoup benefit expenses paid to key personnel. Financial planners use the guaranteed death benefit to recover the loss of assets from estate taxes. There are many ways that your life can change if you knew that your family, business or estate would receive funds upon your demise.

Let’s take one example: Let’s assume that you wanted to leave your children with your assets yet you wanted to increase your retirement income. By utilizing a properly funded whole life insurance policy you could tap into the equity of your home via a reverse mortgage. The monthly payments that you receive from a reverse mortgage are tax-free and you are guaranteed to receive payments for life, similar to an annuity. You can spend down your home equity knowing that the death benefit will replace it upon your death, all while increasing your tax-free retirement income.

When you do pass away your beneficiaries have the choice of paying off the home  or selling it and retaining the income tax-free death benefit for other purposes.

These are some examples of the living benefits of a death benefit. Whether for business or personal use, the guaranteed death benefit enhances strategic business, tax, investing and retirment planning.

Scott Storace

Tags: guarantee, life insurance, tax benefits, tax-free, whole life
Posted in Business Planning, Estate Planning, Financial Strategy, Investment Planning, Retirement Planning | No Comments »

The Great Insurance Debate: Term or Permanent?

March 7th, 2010

Debate The Great Insurance Debate: Term or Permanent?A debate has been raging in the insurance industry since 1977 when Arthur L. Williams Jr., founder of Primerica, mass marketed the concept of “Buy Term and Invest the Difference.” This concept took off like a wildfire and put the proponents of permanent life insurance on their heels. Both sides have been slinging the mud ever since.

Personally, I think both concepts have their merits. If you follow this blog or have been through my website you’ll clearly see that I’m a proponent of a niche within the permanent life insurance industry that is referred to as The Infinite Banking Concept. I’m a big believer in the concept and won’t take your time to re-hash why. See previous blogs. However, I will note that I have never believed that one product or concept fits all. I will use this blog to share both sides of this ongoing debate.

“Buy Term and Invest the Difference” - The concept is simple. Since term life insurance is so cheap as compared to permanent life insurance, it is suggested that you buy it and invest the difference in higher yielding investments.

Pro’s:

  1. Cheap life insurance protection in case of premature death to protect your family. You can buy enough to make sure that your family’s lifestyle does not change when your income is suddenly stripped away., without breaking the bank.            
  2. The securities markets have returned an average of approximately 10% going back to the 1950’s. These returns are much stronger than the 4-5% that most permanent life insurance policies will pay. The growth of your invested money should far exceed the growth in cash values within your permanent life insurance policy.

Con’s:

  1. The name term insurance is derived for the period of time that you purchase it for. You buy it for a specific “term” usually 10 – 20 years. This insurance is cheap in your early years and gets progressively expensive as you age.
  2. It is unlikely that this coverage will ever provide a benefit. Penn State University studied term life insurance and publised their results in 1993. Here is what they found:                                                                                                      1.  More than 90% of all policies are terminated or converted.
    2.  45% of all policies are terminated or converted in the first year.
    3.  72% of all policies are terminated or converted within the first 3 years.
    4.  The average duration before termination or conversion is 2 years.
    5.  Less than 1 policy in 10 survives the period for which it was written.
    6.  After 15-20 years exposure, less than 1% of all term life policies are still in force.
    7.  Only 1% of all term insurance resulted in death claims.
  3. Term life insurance only offers one benefit – financial payout upon death.
  4. Investment returns are subject to fluctuation. The level of risk taken will determine the level of growth. The performance risk is transferred to the owner.
  5. Investment returns are typically quoted as gross rates of return. The net rate of return after capital gains taxes and transaction fees have been paid can be considerably lower.
  6. Many people do not have the financial discipline to “invest the difference”. If not automatically invested then the cost difference ends up in lifestyle expenses.

“Permanent Life Insurance” – This type of insurance is permanent and guaranteed. It is considerably more expensive than term life insurance but offers numerous additional benefits, other than a death benefit.

Pro’s:

  1. These policies have a cash accumulation feature. The cash values within the policy can be used as needed.
  2. These policies are guaranteed. The death benefit is guaranteed to be paid and can’t be taken away. If it is a participating policy, the dividends can not be taken away or reduced. Your premiums are guaranteed. They can not increase as you age or your health detioriorates.
  3. Tax deferred growth and tax advantaged distribution. The cash values grow tax-deferred and can come out tax-free via a policy loan.
  4. Dividends received are non-taxable.
  5. These policies offer a guaranteed internal rate of return typically 4-5%. This return is tax advantaged.
  6. Can employ the Infinite Banking Concept of using the cash values to self-finance. This strategy can greatly increase wealth by decreasing wealth transfers through interest, taxes and fees paid to 3rd party financial institutions.
  7. Offers a death benefit, life term life insurance, that will pass income tax-free to the polciy holder’s heirs. Unlike term life, it’s an instant and permanent asset. This asset can be used strategically as a living benefit (more on this next week).
  8. Since the death benefit and premiums are guaranteed it can be used in a number of strategic tax, business, investing and estate planning applications.

Con’s

  1. Permanent insurance is much more expensive and it’s not affordable for everyone.
  2. Some families & businesses do not need the level of benefits that are provided.

In review: As is the case whenever multiple products are compared, it boils down to cost versus quality. Both term and permanent insurance are excellent. They fit the needs of different people and groups. Suze Orman and Dave Ramsey should know this. It’s common sense. The distinct differences of each should be thoroughly presented. One size DOES NOT fit all. The needs of each individual must be understood and the proper solution applied to each.

Scott Storace

Tags: cash value, guarantee, infinite banking, investing, life insurance, liquidity, safety, tax benefits, tax-free, term insurance, whole life
Posted in Business Planning, Infinite Banking System, Insurance Protection, Investment Planning, Retirement Planning, Whole Life Insurance | No Comments »

Investing in Life Insurance – A Good Return?

February 27th, 2010

I came across this NBC News video this week and thought it would be good to share. A word of caution: If you believe that Dave Ramsey and Suze Orman are financial gods and hang on their every word then I advise you to close your web browser.

If you feel that the generic advice they dispense is more appropriate for people who get their financial plan from watching their TV shows and having their investments handled by multi-level marketing company Primerica then watch this.

Scott Storace

Tags: cash value, investing, life insurance, tax benefits, whole life
Posted in Investment Planning, Whole Life Insurance | No Comments »

Real Estate Investing with the Infinite Banking Concept

February 21st, 2010

monopoly 150x150 Real Estate Investing with the Infinite Banking ConceptI thought I would give an actual scenario this week of how the Infinite Banking Concept is being put to use every day. Like the game, it can become a monopoly!

Assumptions: We have established a whole life policy that’s properly designed for the Infinite Banking Concept. Available cash value for policy loans is $60,000.00.

Scenario: You begin investing in real estate by purchasing a $20,000 rental property. Rent is $750/month. After taxes, insurance and property management you net $500/month or $6,000/year. That’s a 33% annual cash on cash return. You send that $500/month back to your policy to repay the policy loan. So, what do you have? A rental property that you own free and clear with a $500 monthly stream of income back to your policy, and $40,000.00 in your policy.

You use the remaining $40,000.00 in your policy to purchase 2 more properties just like the first. Now you have 3 rental properties that you own outright and positive passive cash flow of $1500 each month.

With a traditional mortgage of $20,000, payments of $500/month and an interest rate of 8% it would take the borrower 47 months to repay the loan. Does the borrower have instant access to their equity? No. They would have to refinance the property, adjust the rate and terms and pay the expenses to do so.

However, one of the best features of the Infinite Banking Concept is the ability to get multiple turns of the money. You don’t have to refinance your loans in order to access the money again. Every time you make a payment back to your policy, those funds get credited to the account and are available to be borrowed again. No questions are asked and no fees are charged. Can you do that with a traditional loan? No. There will come a time when your debt-to-income ratios will be too high or the number of financed properties will exceed the maximum allowed by traditonal lenders.

By re-paying $1500/month in our scenario it will take just over a year before your policy values are back to $20,000.00. Instead of letting it sit in the policy, you borrow it again and purchase another rental property. Now you have 4 properties that you own free and clear with $2,000/month in passive cash flowing back to your policies. Now it will take less than a year for you to accumulate another $20,000.00.

Can you see what’s happening here? By turning your money over you’re amplifying the speed with which your policy values can regenerate. The cycle can be repeated quicker, cash flow will grow more robust and you will be able to purchase more properties over and over again.

In time, you will have a hefty stream of passive cash-flow that will be pouring into your policy. You will own all of your properties outright, minimizing the risk from market downturns. However, you will still be able to enjoy a tax write off on the mortgage interest from the policy loans. As with any write off the paper trail must be properly documented and meet with the IRS standards.

And by paying off your loans completely, you will maximize the growth of your policy. Your dividends will increase, the death benefit will grow and your cash values will flourish. It’s the snowball effect. So, when it comes time to retire, not only will you have that passive stream of rental property income, but you will also have a nice annual tax-free dividend that you can take from the policy. And when you do pass away your beneficiaries will receive the death benefit income tax-free. Plus, they’ll receive a step-up in basis on those rental properties when they are sold. What’s that? Essentially, there will be no capital gains tax on the sale. The previous basis, or amount spent on the property, will be bumped up to the current value. Net tax is 0%!

I’ve mentioned the living benefits that the Infinite Banking Concept offers. This is a prime example of that. Many people see life insurance as one thing…protection in the event of premature death. But it can be so much more than that and that’s the point I want to drive home. The uses are truly infinite!

Scott Storace

Tags: cash value, infinite banking, life insurance, tax benefits, tax-free, whole life
Posted in Financial Advice, Financial Strategy, Infinite Banking System, Insurance Protection, Investment Planning, Retirement Planning, Whole Life Insurance | No Comments »

Life Insurance – The Love Product

February 12th, 2010

heart03 Life Insurance The Love ProductIn the spirit of Valentine’s Day, I wanted to talk about life insurance from a different perspective. Most of my blog is spent discussing the financial and living benefits of life insurance. But life insurance is, and will always be, a means of providing for loved ones in the event of death.  

If you love someone, you protect them. Life insurance is the ultimate form of protection. Who will take care of your spouse and children if you were to perish? Will they be able to maintain the same standard of living? Will they be forced to move from your home? Will your spouse still be able to send the children to college? Who will pay your final expenses?

If you love someone you would not want to pass this burden onto them. You want to guarantee that the plans you have made and the life that they live will continue. The grief of a significant loss is tough enough to bear without adding a hefty fianncial strain. Life Insurance is the only product that guarantees what you want to have happen…will happen!

In a Prudential Financial Inc. study entitled “Life Insurance: A Guarantee in Uncertain Times” they found that 72% of life insurance owners say that this market downturn has reinforced and deepened concerns about providing for loved ones. 94% of policyholders value the guarantee it provides. Market instability, home equity values slashed and unempl0yment at it’s highest level in 27 years it’s not surprising that people are seeking guarantees to protect and provide for their loved ones. 71% believe products with guarantees are worth the cost and 67% of respondents did not fully appreciate all that could go wrong prior to the market downturn.

So, what product provides these guarantees? Participating whole life insurance. It guarantees:

  1. Level premiums that can not increase.
  2.  A death benefit, or financial payout, that will go to your heirs.
  3. Dividends, once delcared, can not be reduced or taken back.
  4. Level costs of insurance that will not increase as you age.

In addition, there are a host of additional financial and non-financial benefits that whole life insurance provides. When it comes to loving and protecting your family…peace of mind tops the list!

Let’s end with a funny but practical video called “Insure your Love” put on by the LIFE Organization.

Enjoy Valentine’s Day with your loved ones!

Scott Storace

Tags: guarantee, life insurance, safety, whole life
Posted in Financial Advice, Insurance Protection, Whole Life Insurance | No Comments »

« Older Entries