Discussion with my Aunt-by-Marriage - VUL related

[dd564]

So my aunt by marriage is a financial advisor, and she knows I like to do my own thing, but she's always big on promoting her products. I like to debate with her on things. This one was about VUL.

She is pro VUL.
I say buy term Life Insurance, invest the difference.

I say, "we invest on a 20 year term which brings my kids age to mid twenties, and then I really shouldn't need life insurance".

She says, "yes but you have nothing left then".
I say, "I don't need it then, plus I have the investments yet".

She says, "okay, but it's not tax-free tax deferred".
I say,

"If I am maxing out my IRA's / 401k's, some of that will be an it's completely liquid incase if I want to move it to a different investment. (real estate etc)."

She then says that the another reason is that life insurance policies won't go through probate or be taxed upon death.

At this point we are getting into the 'I don't know enough' to debate standpoint and just listen.

She implies that VUL's can be good from an estate planning standpoint because it won't go through probate or be taxed upon death at 40-50%.

The argument is essentially move money to a VUL, and it will go to your heirs tax free (or a much lower tax rate). That it by-passes state estate taxes.

Is this true?

[Sarah in SC]

Just one point, I guess, is that those IRAs, term policies that happen to be in effect when you die, and TOD accounts also don't go through probate. And there are many, many estates that pay no taxes, because the taxable portion doesn't meet the threshold.

I think maybe I avoid these kinds of debates like the plague. I don't like to talk about "insurance products" with people who drink the koolaid on them. It is the pig singing story all over again. See:
Never try to teach a pig to sing; it wastes your time and annoys the pig.

I don't bother to know more about them than I absolutely had to in order to pass my exam, and that was far too much. I'd sell plasma before I'd sell VULs, so can't really help with your other questions.

[Big_Hitter]

LI products have many tax advantages, tax-free (or nearly tax-free) death benefits are one of them.

[ERD50]

It's 'true enough' to make up a sales pitch!

Quote:

She implies that VUL's can be good from an estate planning standpoint because it won't go through probate or be taxed upon death at 40-50%.

First, estate tax doesn't kick in until $5.43 million per person, and only the amount above that level is taxed at Estate Tax rates (currently, the TOP rate is 40%) . So unless you are looking at a large estate, it makes no difference.

IRS Announces 2015 Estate And Gift Tax Limits

And the insurance needs to be owned outside the esate to not be considered part of the estate.

-ERD50

[Big_Hitter]

Ask her what the expense and mortality loads are on the VUL product.

[JoeWras]

ERD50 got it. Unless we are talking really serious estate values, don't worry about the taxes.

Second, there are other ways to avoid probate. A simple revocable living trust, for example. And name your beneficiaries properly on the IRA/401k.

[Big_Hitter]

Quote:

Originally Posted by JoeWras ERD50 got it. Unless we are talking really serious estate values, don't worry about the taxes.

what about personal income tax to the beneficiaries?

[AllDone]

Note that that's $5.43M per spouse. There are only estate taxes, if you have eight figures to leave.

[MichaelB]

Quote:

Originally Posted by Big_Hitter what about personal income tax to the beneficiaries?

If I'm not mistaken, under current federal income tax rules inherited money is not considered taxable income.

[Andre1969]

Quote:

Originally Posted by Big_Hitter what about personal income tax to the beneficiaries?

We're going through that with my grandmother's estate right now. Grandmom had some money in some kind of annuity-type thingie with Sun Trust bank in 2006 that was guaranteed to grow by 6% for the first so-many-years, and then reset to market rates. It also grew tax-deferred.

It's at the point where roughly half of its value was in the tax-deferred growth. The estate lawyer told us that the beneficiaries (Mom, my uncle, and me) would have to pay the taxes on the tax-deferred growth.

Grandmom also had an IRA, but because she had been taking RMD's for the past 20 years, it wasn't a whole lot. I ended up electing to take my portion of that as an "Inherited IRA" or whatever it's called. I don't have to pay taxes, but have to start taking RMDs next year, based on my own life expectancy. It may prove to be more trouble than it's worth, keeping track of the RMDs, but if I had simply cashed it out, I would have lost about 1/3 in taxes right away.

I'm not sure, but in general I think you'll have to cough up some taxes, at some point or another, for tax-deferred assets that get transferred. But after-tax assets pass tax free. I believe ROTH IRAs also get to pass on tax free.

[Big_Hitter]

Quote:

Originally Posted by MichaelB If I'm not mistaken, under current federal income tax rules inherited money is not considered taxable income.

generally true although we had to probate my late FILs qualified savings plan last year

[dd564]

What I noticed when talking with her was that the topic would bounce around....

1. If you don't do a VUL, you have nothing. (No, I have other investments then... I would be investing the difference).

2. This is tax free / deferred growth. (Well, so are straight stocks if i just buy and hold, and 401k / IRA are also tax advantaged).

3. But what happens when your term insurance runs out? (I have investments for that... you don't need life insurance your whole life).

4. But you'll safe money from taxes because you won't get taxed at 40%. (I don't think my estate's net worth will be worth the threshold.

5. But what if democrats get elected and lower that. (I doubt it will get lowered to my level).

6. But what if you have to take care of your brother in law who has issues. You would want a trust set up for that with a VUL. (If I have to take care of him, and i setup a trust, why would I need a VUL)?

A lot of problems are offered out as if the VUL solves them, but regular tools would already solve those (and are simpler to use / understand.

VUL's have too many moving parts to truly understand.

[JoeWras]

Quote:

Originally Posted by Andre1969 It's at the point where roughly half of its value was in the tax-deferred growth. The estate lawyer told us that the beneficiaries (Mom, my uncle, and me) would have to pay the taxes on the tax-deferred growth.

See, this is where equities are simple. No matter how the equity is titled (personal or trust), you step up the basis at death. Now there may be a gain after death where the gain passes through to the beneficiary, but that's understandable. Usually it is small in the scheme of things.

Annuities are a complex mess of junk. It depends on the type of annuity. Simple deferred annuities (CD look alikes) are tax free during the term of the annuity, but you pay all the gain at the end.

Many retirees are encouraged to get these because they are simple as far as annuities go. And they pay better rates than CDs. When the term is up, the FA will suggest rolling into a new one so you don't have to the pay the tax. Many retirees are happy with this.

But they are leaving a time-bomb for their heirs. And it doesn't matter if it is left to a trust or not. If the heir is the trust, then the income passes through to the beneficiaries anyway.

So, yeah, Andre and Big_Hitter, your points are very well taken.

The OP was talking about a VUL, and god only knows what the rules are for that mess. I'll take the FA's word for it that there must be some kind of step-up. But who knows?

Equities, my friends, are so simple in comparison.

[JoeWras]

Quote:

Originally Posted by Big_Hitter generally true although we had to probate my late FILs qualified savings plan last year

Note: "probate" and "taxable" are different concepts.

[gauss]

Politely decline to discuss this further with her. Your knowledge so far shows that you would not benefit from a financial relationship with her. Who want to have a financial relationship with family members anyways? Sounds like a recipe for disaster.

How long has she been doing this (professional FA)? Trying to exploit family and friends sounds like an introductory move before the FA builds up their "client base".

Either she doesn't know anything more than the sales training she has received, or she is putting her interests ahead of you and DW.

For fun, ask her if she takes on clients governed by a "fiduciary standard" of responsibility to you (not the common suitability standard). Answer No? Why am I not surprised.

-gauss

[RetireBy90]

Quote:

Originally Posted by Andre1969 Grandmom also had an IRA, but because she had been taking RMD's for the past 20 years, it wasn't a whole lot. I ended up electing to take my portion of that as an "Inherited IRA" or whatever it's called. I don't have to pay taxes, but have to start taking RMDs next year, based on my own life expectancy. It may prove to be more trouble than it's worth, keeping track of the RMDs, but if I had simply cashed it out, I would have lost about 1/3 in taxes right away.

Dad left a small Traditional IRA, and I have been drawing RMDs for last 15 years, since he was required to take RMDs the year he died. I now have a little more than what he left and the RMDs have been about 7-8% of the balance. Draws from this are in fact taxable, reported on 1099R like your own IRA or 401K. Mom will leave little more than dad ad I'll do the RMD thing with whatever she passes along also.

I'm sure there are times it could be better to take cash our and pay the taxes now but I wouldn't change the way it has worked since 2000.

[pb4uski]

You got it. My BIL is an insurance agent (actually two BILs at one point) so we have had many such discussions but they weaned out over the years once he realized that there is no sale to be had. Luckily, I worked in the industry and knew enough to joust with him and hold him at bay.

Life insurance is only tax-free if you keep it until you die and your beneficiaries receive the tax-free death benefit. But you know that after you are a certain age that it is likely that you will no longer need life insurance so with a VUL you could for many years be paying for life insurance coverage that you don't need or want.

If you "invest the difference" then the nature of an investment is you want to use the money someday. When you withdraw VUL money, a portion would be taxable (withdrawals in excess of premiums as I recall) so it is tax-deferred (not tax-free).

If incrementally you're investing the difference in a tax-deferred retirement account then it will be just as tax-deferred as a VUL. If incrementally you're investing the difference in a tax-free retirement account (like a Roth) then it will be tax-free but you don't have to die to savor the tax-free benefits like you do with a VUL. Alternatively, if you are investing the difference in equities in the taxable accounts and are in the 15% tax bracket then qualified dividends and LTCG would be tax-free... even better than VUL since you don't have to die to get a tax-free benefit.

The probate argument is silly because investment accounts can be set up with named beneficiaries and those don't got through probate either. Unless your estate will be over $5.43 million then the estate tax argument is baloney.

If you BTID and invest the difference in a Roth that has beneficiary designations then you'll get the same benefits (tax-free and avoids probate) and also avoid estate taxes as long as your estate is less than $5.43 million. And it is a lot simpler and will likely grow faster. The only bad part is that your aunt won;t get a commission on it.

The problem with VUL is high fees and at some point likely having to pay for insurance that you don't really need. She's blowing smoke up your you-know-what... when the only tool you have is a hammer, every problem looks like a nail.

[Andre1969]

Quote:

Originally Posted by RetireBy90 Dad left a small Traditional IRA, and I have been drawing RMDs for last 15 years, since he was required to take RMDs the year he died. I now have a little more than what he left and the RMDs have been about 7-8% of the balance. Draws from this are in fact taxable, reported on 1099R like your own IRA or 401K. Mom will leave little more than dad ad I'll do the RMD thing with whatever she passes along also. I'm sure there are times it could be better to take cash our and pay the taxes now but I wouldn't change the way it has worked since 2000.

I ran the numbers for my inherited IRA through an RMD calculator, at Beneficiary RMD Calculator | Charles Schwab

I'm 45. Looks like for this year, Grandmom's estate has to take out an RMD of about 9%. It's about $3000 total, and her RMD is listed at $277. Then in 2016, I only have to take out about 2-3%. That percentage slowly rises, until it's completely depleted when I'm 83. No matter what I set the projected interest rate at, (the Schwab calculator lets me change it from 0-12%), it looks like it's designed to totally deplete at age 83 for me.

[RetireBy90]

Quote:

Originally Posted by Andre1969 I ran the numbers for my inherited IRA through an RMD calculator, at Beneficiary RMD Calculator | Charles Schwab I'm 45. Looks like for this year, Grandmom's estate has to take out an RMD of about 9%. It's about $3000 total, and her RMD is listed at $277. Then in 2016, I only have to take out about 2-3%. That percentage slowly rises, until it's completely depleted when I'm 83. No matter what I set the projected interest rate at, (the Schwab calculator lets me change it from 0-12%), it looks like it's designed to totally deplete at age 83 for me.

If I understand it that is the plan, tables look at your projected longevity or the age they project a 45 year old to pay taxes upstairs. Then they take your years remaining (38 in your case) and take out 1/38th. Next year 1/37th and so on. Each year your projected longevity uses a different table, next year you will use the table for male 46 year old. As the weak ones drop off, your longevity will increase and your RMD percentage will be lower cause if you don't die you will live longer. (hmmm wish I had said that ).