What you’re about to learn will change the way you view life insurance and by the end of this video, you’ll be more knowledgeable than most life insurance agents. Ready? Good. Let’s get started. Life insurance design is all about premiums.
While insurance companies set the minimum amount of premiums to be paid for a given level of coverage, most people aren’t aware that the federal government puts a threshold on the maximum you’re allowed to pay into a policy.
The insurance companies employ people called actuaries. An actuary will calculate your minimum amount based on two things. First, the likelihood you’re going to file a claim and second on the amount they need to cover your claims and still make a profit. And since the government sets your threshold, they limit the amount of tax advantage growth you can achieve.
If you place more money into your policy than the government threshold, it becomes known as a modified endowment contract or MEC and that can happen without you even knowing that it happened. This means the government will treat your insurance contract just like they do one of their own government-sponsored retirement plans with all of their designated rules, regulations and penalties.
These government-sponsored retirement plans include 401ks IRAs, SEPs, 403B plans and the like. In the 1980s legislation was put into place TAMRA and DEFRA drew the line in determining the maximum contributions allowed for a given policy.
Up until that point, there was an infinite amount of premiums that could be paid into a policy. So the government had a problem on its hands. They realized they couldn’t allow unlimited contributions and cash access because it was too advantageous.
Making all government-sponsored plans look bad. So why do people still use these government-sponsored plans? The typical response is that they save and or defer taxes. Well, it might shock you to know that’s not as much of a benefit as you’ve been told. Let’s say you wanted to borrow $10,000 you’d probably ask yourself two questions.
How much interest, why I have to pay and when do I have to pay it back? If the lenders said, we have enough money right now and don’t need any payments from you at this time, but there will come a time when we’ll meet it. When that time comes and we’ll decide how much we need and how much interest we have to charge. Would you cash that check?
Absolutely not. What you don’t realize however is you are already cashing those checks when investing in government sponsored plans, the government is not saying you don’t owe the tax. They are saying you can pay the tax later, but at a ‘to be determined’ tax rate. In other words, you are sitting on a ticking tax time bomb.
This is not to say government sponsored plans have no value. It’s just important to know and understand exactly what they do and what they don’t do.
Now let’s look at an example using a properly structured life insurance product. When purchasing a new life insurance policy, you have two options, both with an equal face value or death benefit of $500,000 one requires you pay a premium of $500 and one requires a premium of $10,000 which would you choose?
Most of us would probably pick 500 right? But what’s the catch? The $500 option is what is known as a term insurance policy.
Term policies have the lowest possible premiums offering protection for the lowest initial cost. However, they only last for a set period of time or term and they only provide a single benefit known as a death benefit. The problem here is that the best day from a financial standpoint to own such a policy is the first day you own it.
If you purchase the policy today, received approval, sign on the dotted line and then died on the way home, you’d be getting maximum benefit for the lowest cost. To calculate a rate of return on such an event would be next to impossible.
If the first day is the best day to own such a policy, then that policy becomes worth less and less while costing you more and more. Like any other financial investment, one must consider opportunity costs when pricing term insurance.
You must keep in mind that the total cost is not simply the premium paid but the loss of potential earnings those dollars could have generated. Penn state university completed a study on term insurance policies and discovered that more than 90% of all term policies and without paying out any benefit to the policyholder, 90% less than one policy and 10 actually last the time period for which it is written and only 1% of all term insurance resulted in death claims.
What does this mean? It means you will most likely pay more than you receive. In fact, there is a 99% chance that will be the case. To sum up, term insurance is not a wise long-term strategy.
Now back to our other option, the $10,000 policy would have to have some serious benefits to make sense. Wouldn’t you agree?
Well, if you were to construct an ideal investment, what would it look like? You would want to achieve an acceptable rate of return, of course, but what additional benefits would you desire?
You would want tax-deductible contributions, tax-deferred growth, tax-free distributions, liquidity or access to and control of your money, a guaranteed minimum interest rate, liability and asset protection, freedom to choose your own investments, the ability to use the funds as leverage collateral, easy access to your money during your working years, and also a source of income during your retirement and contingencies for any interruption to the plan due to death, disability, emergency, or lawsuit.
Of course, you would want all of these benefits. Well, there was only one product available that can deliver the majority of these benefits. That product is permanent life insurance, not to be confused with your average run of the mill life insurance.
Life insurance policies that are minimally funded provide only minimum levels of benefits, so pay attention. As we talked about before, the government sets the threshold that determines the maximum allowable contributions and contributions over this line create a modified endowment contract or MEC.
However, contributions made right up to this line create a different type of MEC that we will call the maximum efficient contract. Permanent life insurance contracts offer all the benefits listed earlier except that the contribution to a life insurance contract outside of a government-sponsored plan is not tax-deductible.
Here is what you need to know. As you move from the highest possible premium to the lowest the value of the benefits decrease. The higher the premium, the higher the level of each benefit received until you reach the MEC line.
Up to that line but not over is the position that provides the greatest amount of benefits a life insurance contract has to offer while still allowing access to your capital. There are circumstances in which one only needs death protection and a low level premium is desirable, in this situation and when coverage is needed for a short-term period of time, term coverage may be the best immediate, albeit temporary solution.
If however, you’re looking for a place to accumulate money that provides the highest level of benefits mentioned, permanent life insurance is a wise choice. Currently, there are no other financial products that offer these same benefits at the same level, how much insurance should you have? Most of us assume this is a needs decision however, it’s really a desire decision.
The reason being life insurance is the only product that can provide the resources even if you do not live long enough to accumulate them. There is no one wise enough to determine what he needs since the very thought of need only represents the least amount necessary, it would be hard to find anyone who has been successful at anything who began by calculating the bare minimum they would have to do to become successful.
Life insurance is a want product that can provide financial benefits and peace of mind. You decide how much it will take to accomplish what you want, to live the quality of life you want. Life insurance is the only product that can provide the immediate funds to guarantee that what you want to happen will happen.
Make sure the policy you own will ensure the same. If at any point in this video we have raised questions about your current policy or the ideal policy you would like to create, contact us for more information. We can take a look at the benefits you might be missing.
Just give us 15 minutes to ensure you have the plan that allows you to achieve the wealth you desire while also creating a foundation of protection for yourself, your family, and future.
