Torturing the Numbers of “Missed Fortune 101"
Copyright 2006, The WPI
By: Roccy DeFrancesco, JD, CWPP™ CAPP™ Founder The Wealth Preservation Institute (www.thewpi.org; firstname.lastname@example.org) Co-Founder: The Asset Protection Society (www.assetprotectionsociety.org) What is the definition of the “truth?” Depending on where you look, you’ll find: -Conformity to fact or actuality; -A statement proven to be or accepted as true; -Sincerity; integrity. Have you ever heard someone say that truth is relative? How can truth be relative? Isn’t the truth simply the truth? I don’t want this to be a philosophy newsletter, but I’ve found when dealing with advisors who tout funding a cash value life insurance policy INSTEAD of funding, in an income-tax deferred manner, a 401(k) plan /IRA, that the truth can, in fact, be relative. What do I mean? The truth is in the math presented to the client and the math can change dramatically depending on the assumptions used to come up with the desired conclusion. I sometimes receive grief for picking on the book Missed Fortune 101. As I’ve stated a number of times, I like the idea of taking equity out of a house and funding life insurance when you can write-off the interest on the loan (assuming the concept is implemented for the "right" client). That’s not what this newsletter is about. It’s about the section of Missed Fortune where it is pronounced that funding a "cash value" life insurance policy post-tax as an investment is superior to funding a qualified plan with pre-tax money. I put together these types of newsletters not necessarily to give you the “right” answer to things, but to make advisors think critically on all matter including this one. I think you can make up your minds for yourselves. I created 6 spreadsheets for your review. I assume the client is either going to fund $5,000 incometax deferred into a 401(k) or IRA, let it grow from ages 45-65 and then take distributions from ages 66-85; OR the client will take the $5,000 home as income, pay tax on the money in their current tax-bracket and fund a cash building life insurance policy where the client will take “tax-free” loans from the policy from ages 66-85.
FYI, the most common complaint I received from my last newsletter on this topic was that I did not assume the client would be in a higher tax-bracket in retirement. I don’t believe that will be the case for most of our clients, but if you do, check out the math for yourself and see how things turn out. The second complaint I received was that I did not factor in that a client can get rid of their current life insurance policy/premium if they fund life insurance as an investment over a qualified plan and that will help the math and the sale of insurance. That is true, but for most clients, funding $3,000-$4,500 into a cash building life policy is typically going to get them less than $250,000 of insurance coverage. I would not want a client to stop paying their $400-$700 term life premium and get rid of their $1,000,000+ life policy because they purchased a cash building policy with a $250,000 death benefit. Therefore, I did not include a reduction in term life premiums in my calculations.
In order to help the sale, I also created illustrations where I assumed the money in a 401(k) plan or IRA has an annual money management fee of 1.2% (average for a mutual fund). In order to make an illustration
that I thought was more real world; I also created a spreadsheet where the money management fee is .4% (because many people use indexed funds which have low management fees). If you are not interested in downloading and reviewing the spreadsheets for yourself and want my conclusion to this topic with the assumptions I’ve used, the answer still remains that it is better or much better the vast majority of the time for a client to fund their 401(k) plan or IRA instead of funding life insurance as a post-tax investment. To download printable spreadsheets, please click here. Spreadsheet 1-Client is in a 10% and 20% higher tax bracket in retirement (No money management fee is assumed in the 401(k) plan or IRA). Spreadsheet 2- Client is in the SAME tax bracket in retirement and there is a .4% management fee on the money in the 401(k) plan or IRA. Spreadsheet 3- Client is in a 10% higher tax bracket in retirement and there is a .4% management fee on the money in the 401(k) plan or IRA. Spreadsheet 4- Client is in the SAME tax bracket in retirement and there is a 1.2% management fee on the money in the 401(k) plan or IRA. Spreadsheet 5- Client is in a 10% higher tax bracket in retirement and there is a 1.2% management fee on the money in the 401(k) plan or IRA. Spreadsheet 6- Client is in the SAME tax bracket in retirement and no money management fee.