So last time we dove into general design, and this time around we'll be addressing why this is such a great idea. I left off the last post with 8 reasons for using cash value life insurance as a spot to store emergency fund cash. If you forgot here they are:
- Increased rate of return
- Tax deferral
- Potentially tax free withdrawal
- Death benefit
- Private and non-probate asset
- Fewer fees (in most cases)
- Recaptured opportunity
- Systematic savings
Increased Rate of Return
Paid-up Additions (the rock stars in our cash accumulation discussion) yield a way better return year over year and from an internal rate of return point of view than a standard savings account (and also better than CD's and Money Market Mutual Funds). The rate will vary from carrier to carrier, but you should expect a pretty decent 5% or so return here very early on. For those still interested in UL, you need only look at the UL crediting rate (which for most carriers is bouncing somewhere between 4 and 5%). Remember, not only is it higher, it's tax deferred.
What? Tax Deferred you Say?
In case you forgot about the graph comparing tax deferred vs. taxable savings accounts from a week or so ago, we'll pull it out again here:
Remember, blue curve represents tax deferred account and red curve represents taxable account. Over time, a lot of money is lost due to the tax-ability of the account. So, more money in your pocket, and fewer 1099's to keep track of during tax season (also potentially meaning fewer pages in your tax return, which hopefully means fewer “copy charges” from your accountant). The favorable tax treatment doesn't stop here, though.
And Tax Free Withdrawals, too?
Life insurance enjoys a FIFO (first-in-first-out) withdrawal for tax consideration. Meaning you can pull out your entire cost basis (whatever you've put in) first before touching any of the gain in the policy. After the basis has been withdrawn, you can continue to withdraw through a policy loan. And since loans are not technically withdrawals they aren't taxable (unless you have a modified endowment contract, if you're leaning towards the MEC strategy outlined in part 1 for the older folks, this one bullet point simply doesn't mean very much to you, so 7 good reasons instead).
Death Benefit
Capital One currently has a commercial running with Jimmy Fallon asking folks: “who wouldn't want more money?” There's a similar question here. Not only will your savings be augmented by a greater rate of return, but its value will be augmented from a transfer of wealth point of view, significantly increasing the overall value of the policy. If we go back to the parameters from the graph above and quickly plug that into a common contract we use at the Salus Agency we find that after 45 years the c. $790,000 in cash value is there, and the death benefit is $1.2 million. For those who are keeping score, we'd need about a 6.67% return on a MMMF or CD to match that IRR cash result and an 8.69% return to match the death benefit result (good luck with that if you're a hold out).
If extra money for your loved ones isn't enough to get you excited (they get too much as it is, right?) there's something else about the death benefit discussion that is worth a lot of consideration.
How to Decrease the Cost of Probating your Estate, WARNING will probably upset your Attorney
The a life insurance contract is…(get this) a contract. In it's simplest/purest essence it's a formal agreement between you an a financial intermediary that promises to pay a named party (or parties) a certain amount of money upon your passing as long as the policy is in force on the day you die. In return, you agree to pay a premium. Ok, that was stuffy and boring enough for one post, but hidden under that little reminder was a gem in estate planning (and whether you like it or not, everyone must do some degree of estate planning, no matter how poor they think they are).
Life insurance death benefits by pass the probate process. For years, I've participated in a lot of public informational mediums on the topic of life insurance and personal finance-related topics, and one of the most common issues that comes up is the contradiction of a Last Will and Testament with a beneficiary designation in a life insurance contract. It's like a bad sitcom rerun that never dies (pun totally intended). Someone died, should have made some changes to a beneficiary designation somewhere, but figured simply stipulating things in a new Will would solve the problem, WRONG!
Life insurance contracts are a separate matter that bypass (for the most part) the probate process. The death benefit is paid directly to the beneficiary (or beneficiaries). There are some estate considerations for inclusion of life insurance directly owned by an individual in that individuals gross estate (and currently if this amount if under $5 million it means no big deal as you won't break out into estate taxable territory for Federal Estate taxes (do check on your State's specific limits, though). For most people this isn't an issue, and for your safety money, this probably isn't going to become an issue. So, instead of having to worry about where the money in your savings account goes, and to keep it out of the prying eyes of those who understand Wills are public documents (yes, in most cases you can go to the courthouse and see who left who what for money in their Will, try it if you don't believe me).
If the assets pass right to a beneficiary instead of getting caught up in your estate, there are a few things that happen:
- If you die with debts, the assets cannot be taken by a creditor, since they can only place a lien against your estate
- Building off the debt piece, if you end up as a Medicaid beneficiary, there is no claim to this money from Medicaid since it doesn't end up as part of your estate
- Having this asset avoid the probate process decreases the overall value of your estate, which decreases (in most cases) attorney's fees to probate your estate
- If you wish to change the beneficiary, all you need to do is fill out and sign a form. There's no cost like changing a Will and there's not scheduling time to meet with your attorney
- There's really no waiting for the transfer (anyone who has acted as executor or been named an heir of money from a Will knows what I'm talking about here).
Since we're well over the 1000 word count I mentioned last time, I'm going to end it here for now. Part 3 roll out first of the year.
See you next year!
