Life Insurance SCAM??

[Big Game James]

Hello Everybody,

There's a lot of stuff we've seen with Life Insurance and I've read in both Suze Orman and Dave Ramsey's books that they are all about term and invest the rest. Ed Slott on the other hand I have two of his books and he's saying the exact opposite. Please let me know what you guys think as I'm pretty curious and I'm a firm believer in throwing everything on the plate so if something is unkosher we can call it out for what it is..

I have my personal beliefs on this stuff and is just curious to see what ya'll think...

Here's Ed Slott- it's a crappy video but he slightly slaps IRA and waves the whole life insurance flag which is completely counter everything we're taught from the other two..
Ed Slott on the Biggest Benefit in Tax Code - YouTube
Here are Orman and Ramsey on the same thing..
Dave Ramsey Life Insurance Explained - Slams Whole Life - YouTube
Suze Orman on Life Insurance: Term Life Insurance vs. Whole Life - YouTube

 

[harley]

They're talking about different things. Dave and Suze are talking about getting insurance to cover loss of family income due to death of the breadwinner. They're ending where Ed Slott is starting. Ed is talking about how to protect your money for your heirs. He's using insurance to pass money through to the next generation instead of leaving the money in an IRA where it will be taxed at significant levels. His biggest advice is to take your money and gift it to an heir. They then buy a big life insurance policy on you. When you die they get the insurance money, which having never been part of your estate is not subject to estate taxes or IRA withdrawal taxes. It's a good idea, assumig you plan to leave money to people other than your spouse. Dave and Suze are talking grade school financially. Ed is AP high school.

Edit: I re-read your question and it appears you're saying Ed Slott is pitching whole life or Universal life vs. term life, which is what Dave and Suze are recommending. I've read a number of his books and don't remember anything particularly spelling out which type of insurance to buy. However, in this case I would suspect a whole life style of policy would be best. You could outlive a term life policy, and then re-upping it at an advanced age could be prohibitively expensive, if they even let you do it. For income replacement insurance I would definitely go with a limited term term life policy for however long the income would be needed. But for the Ed Slott plan I would at least look into a whole life policy. It goes a little against the grain, but in this particular case I think it would be the better choice.

 

[73ss454]

We've talked about Ed Slott recently on another thread. I think the general opinion is that using Ed's plan you are better off dead. Great plan for the next generation but not so good for the living.

 

[MasterBlaster]

We've talked about Ed Slott recently on another thread. I think the general opinion is that using Ed's plan you are better off dead. Great plan for the next generation but not so good for the living.

I suppose you have to determine which is the lessor of the two evils. Estate taxes on your estate or insurance company fees and expenses. Note that neither of them are low and vary with the size, and makeup of the estate.

When that is determined it will be clear which is the better method to leave something to your heirs.

Not only can estate taxes be outrageously (perhaps confiscatorily) high especially when the bulk of the estate is held in qualified assets (ie. IRA/401k etc.), but Insurance fees can be outrageously high - So do your due diligence.

 

[73ss454]

I would think it depends on the size of the estate. Most folks wouldn't be in a taxable situation. If you are or have a family business that's worth tons of money it may be a good thing to consider Whole Life.

I bought 3 whole life policies in my life and all 3 ended up in class actions. Still holding one but I'm sure I should have never bought it. I'm still trying to decide what to do with it at this point. I don't have enough money to be in a taxable situation and no family business to pass on so I should have bought term IMHO.

 

[harley]

I can't believe I'm defending whole life at all. Talk about being the devil's advocate. But the problem with whole life for the most part is the high fees and crappy investing returns. This makes whole life a totally unsuitable method of saving for retirement. However, if you approach it from outside the box as Ed Slott is, you realize you are basically not considering the investment aspect of the policy. You are counting on the inevitable payout upon death. Say you only earn 1-2% on a 5 million dollar policy over a 31 year period. But then when dear old dad dies you get the 5 million, assuming you made all the premium payments with the money he gifted to you over the years. If you had taken out a 30 year term policy on DoD, you'd have been out of luck and would have to have been putting banana peels on the stairs in the 30th year. It's not a life insurance policy at this point. It's an estate tax avoidance policy.

This is not an issue that makes much of an impact on this board. Most people here plan on spending their money, or just leaving whatever is left to heirs. Ed Slott's advice is targeted to those who plan on leaving a significant legacy to the next generation or two.

Personally I think if the practice moved beyond the super rich into the moderately wealthy the way Ed Slott is recommending, something would be done to stop it, either by the insurance companies or the gov't.

 

[Nords]

This seems way overcomplicated. Although it comes with free earnest admonishments, screeching, and frighteningly white teeth.

My guess is that insurance should be either be level term to hedge the risk of my death while someone was depending on my income, or an estate-planning tool to help divide the estate among the heirs more equally and minimize estate taxes. Anything else seems to be a pale imitation of another financial product, only with some "insurance" of a minimum standard of performance. Those risks of loss of principal could also be hedged away by low-cost diversified index funds.

I have to admit that comparing the three of them sounds like a bad joke:
"Ed Slott, Dave Ramsey, and Suze Orman walk into a bar"...

 

[ERD50]

... Ed is talking about how to protect your money for your heirs. He's using insurance to pass money through to the next generation instead of leaving the money in an IRA where it will be taxed at significant levels. His biggest advice is to take your money and gift it to an heir. They then buy a big life insurance policy on you. When you die they get the insurance money, which having never been part of your estate is not subject to estate taxes or IRA withdrawal taxes. It's a good idea, assuming ....

Assuming you completely ignore an important point.

When people propose gifting and buying insurance, they always sidestep an inconvenient truth. As you say above, the money is gifted to an heir, and they buy the insurance. What gets ignored is, gifting the money (within annual limits) gets it out of the estate and out of the IRA (if that is the source) so it is also 'not subject to estate taxes or IRA withdrawal taxes'.

It is the gifting that accomplished the tax dodge, not the buying of insurance with the gifted money.

So, looking at it that way, it boils down to an analysis of whether whole life is a good investment. I sure would not bet against an insurance company and expect to make a profit. I buy insurance to pool risk, and expect to pay a premium to do so. Otherwise, the ins co would go out of business and not be able to pay my claim.

-ERD50

 

[FinanceDude]

Ed Slott's advice cater to people who have considerable wealth and a tax problem to fix. Suze caters to people who are debt up to their eyeballs and have made bad choices financially. Dave Ramsey caters to some of both.........

 

[pb4uski]

Well, for one, Ed is talking about life insurance, not necessarily whole life insurance. That said, there are situations where whole life is useful like in estate planning where one need mortality coverage for a long period of time.

I suspect that Ed would go on to say to use part of that $10m IRA to buy life insurance and use the tax-free death benefit to pay for final expenses and taxes on the IRA when it is taken after the IRA owners passing.

Not sure I agree with what Ed says, but I think that is probably where he was going reading between the line - though from what i have seen of him it would be another half hour before he would get there.

 

[harley]

Assuming you completely ignore an important point.

When people propose gifting and buying insurance, they always sidestep an inconvenient truth. As you say above, the money is gifted to an heir, and they buy the insurance. What gets ignored is, gifting the money (within annual limits) gets it out of the estate and out of the IRA (if that is the source) so it is also 'not subject to estate taxes or IRA withdrawal taxes'.

It is the gifting that accomplished the tax dodge, not the buying of insurance with the gifted money.

So, looking at it that way, it boils down to an analysis of whether whole life is a good investment. I sure would not bet against an insurance company and expect to make a profit. I buy insurance to pool risk, and expect to pay a premium to do so. Otherwise, the ins co would go out of business and not be able to pay my claim.

-ERD50

I'm not sure your different angle makes any difference. Sure, the gifting of the premium cost is what makes this work, but you can gift for a long long time and never get the amount out that the insurance will pay. The insurance as an investment is pretty much inarguably a bad deal. But the payout after death is a great way to redirect the inheritance. And it's not really a tax dodge. The gov't still gets their cut from the remaining estate (minus the part used to pay the premiums), the heir gets more money with less taxes due to the policy, and the insurance company eats the payout within their normal actuarial calculations. As I said, if more people started doing this it would fall apart. The insurance companies would crank the price or drop the option. But as an existing inheritance loophole it would work pretty well.

 

[ERD50]

...but you can gift for a long long time and never get the amount out that the insurance will pay. The insurance as an investment is pretty much inarguably a bad deal.

But the payout after death is a great way to redirect the inheritance.

But don't those contradict?


If the insurance as investment is inarguably a bad deal, that means the payout is on average less than what went into it (adjusting for the time value of the money). So why take the gifting and invest it in a bad deal? The gifted money is out of the estate already and escaped taxation. 'Investing' it in a life ins policy doesn't get it any more removed from the estate than it already was. So it isn't a tax decision any more, it's a decision that LI is a good investment, and you said it wasn't (and I agree).

Sure, if the insured dies after only a few years of insurance premiums are paid, that leverages the tax-free amount the heirs would receive. But that is true w or w/o the tax issue. And ins cos have the odds calculated pretty well on average. You really want to bet against them (hypothetically)?

-ERD50

 

[heirloom]

When we were working, our employer had insurance we could purchase in case we died....pretty cheap and I think it is worth it for young people. Most employers probably have it.

We went to a yearly credit union dinner and the man we were sitting beside has 20 yr. term insurance which will expire in 2 yeasr.... He's in his 70's. SO, be careful how long a term you get, depending on your health.

I'm more interested in getting our son an insurance policy where he can get money tax free. Is there one where you pay up front a certain sum and he can cash the policy with interest/tax free? Or does he have to buy it for us? I think since I'm ONLY 62, it should be a while before I croak, so the policy should be worth a nice investment for him tax free.

 

[2B]

I have seen whole life insurance used once as an estate planning tool. The individual owned a family business worth many, many millions. He created a separate family trust that he funded somehow avoiding serious taxes but I know he paid serious legal fees to create it. This trust bought paid up whole life insurance on him that was designed to pay the estate taxes on the business so that it wouldn't have to be sold upon his death. The whole life policy was priced based on his health and age at the time so he got a substantial discount on the face value prior to his death decades later. As the company grew in value, he continued funding more insurance. It actually worked pretty well from what I have heard.

This is one situation that seems to actually make sense to go with a whole life policy. Also, very high income individuals can also make good candidates for variable annuities. I have heard of plans for this rare breed that make sense but we mere mortals don't have the option or need to buy these.

 

[ERD50]

I have seen whole life insurance used once as an estate planning tool. The individual owned a family business worth many, many millions. He created a separate family trust that he funded somehow avoiding serious taxes but I know he paid serious legal fees to create it. This trust bought paid up whole life insurance on him that was designed to pay the estate taxes on the business so that it wouldn't have to be sold upon his death. ...

I can understand how they could be used for liquidity in a case like this. I wonder if there aren't cheaper ways to go about it though.

But I still question its value as an 'investment'.

-ERD50

 

[harley]

But don't those contradict?


If the insurance as investment is inarguably a bad deal, that means the payout is on average less than what went into it (adjusting for the time value of the money). So why take the gifting and invest it in a bad deal? The gifted money is out of the estate already and escaped taxation. 'Investing' it in a life ins policy doesn't get it any more removed from the estate than it already was. So it isn't a tax decision any more, it's a decision that LI is a good investment, and you said it wasn't (and I agree).

Sure, if the insured dies after only a few years of insurance premiums are paid, that leverages the tax-free amount the heirs would receive. But that is true w or w/o the tax issue. And ins cos have the odds calculated pretty well on average. You really want to bet against them (hypothetically)?

-ERD50

No, no contradiction. I'm not going to go beyond this comment because I've seen your ability to argue a point interminably. But there's a difference between investing for your own return using a whole life policy (Bad) and investing in a whole life policy to pass an estate through to an heir with fewer or no taxes (Good from the point of view of the heir). Doing this can pass through millions of dollars to an heir while only paying thousands, or tens of thousands, or even hundreds of thousands of dollars in premiums (depending on the policy and how long you live). Compare that with the 55% hit on the non-excluded estate. If you are one of the people in the position Ed Slott is targeting, this can be a real good idea. If you aren't, it's not. If there was a way to do the same thing with term life I would prefer it, but with term there's always the chance you'll outlive the policy term.

When we were working, our employer had insurance we could purchase in case we died....pretty cheap and I think it is worth it for young people. Most employers probably have it.

We went to a yearly credit union dinner and the man we were sitting beside has 20 yr. term insurance which will expire in 2 yeasr.... He's in his 70's. SO, be careful how long a term you get, depending on your health.

I'm more interested in getting our son an insurance policy where he can get money tax free. Is there one where you pay up front a certain sum and he can cash the policy with interest/tax free? Or does he have to buy it for us? I think since I'm ONLY 62, it should be a while before I croak, so the policy should be worth a nice investment for him tax free.

AFAIK, the only way to pass money to your son tax free is to have him own the policy. Which means he has to make the payments, although you can gift him the money to do it with. You can probably set it up so you gift to a particular account that the premium is automatically paid from. But there's no guarantee he won't mess it up. Once the money is gifted you have no control.

Of course, if your estate is below the estate tax threshold there's no federal tax. And depending on your state tax there may or may not be an estate tax or an inheritance tax. So the only way to pass an estate larger than the estate tax limit du jour tax free is through an insurance policy on you owned by him. Again, as far as I know. The lawyers might have some secret techniques I'm not aware of.

 

[brewer12345]

I can understand how they could be used for liquidity in a case like this. I wonder if there aren't cheaper ways to go about it though.

But I still question its value as an 'investment'.

-ERD50

There is little value in any of this as an investment. Life insurance companies largely invest in investment grade bonds. Basically, that is all the return they have to work with in order to cover the benefits they will eventually pay out. Some types of policies are also supported by lapses. Out of this rather meager stream of money (plus your premiums) they have to pay agents' commissions, taxes, regulatory fees, overhead, etc. before they even start covering benefits. These companies can be relatively efficient, but they aren't magic factories.

 

[ERD50]

No, no contradiction. I'm not going to go beyond this comment because I've seen your ability to argue a point interminably. But there's a difference between investing for your own return using a whole life policy (Bad) and investing in a whole life policy to pass an estate through to an heir with fewer or no taxes (Good from the point of view of the heir). Doing this can pass through millions of dollars to an heir while only paying thousands, or tens of thousands, or even hundreds of thousands of dollars in premiums (depending on the policy and how long you live). Compare that with the 55% hit on the non-excluded estate.

Well, I was just continuing the discussion to see if there is a hole in my thinking. I don't trust my own thinking, so I try to see if the smart people on this forum can challenge it and point out if/where I made a mistake. To me, that is different from 'arguing', but we all see things differently.

But the way I see it, once the money is gifted, the estate tax has been eliminated for that gifted money. So now the question is not about reducing estate taxes, it's about whether that gifted money will return more to the heirs by 'investing' in LI, or by other means. The giftee can take the $10,000/year (or whatever, up to the annual limit) and put it in Wellesley each year and let it grow (the growth/divs will be subject to income tax). Or put it into a LI policy each year. For the LI policy to be a better choice, it would need to be a better investment than Wellesley (or other proxy). How can it be otherwise?

AFAIK, the only way to pass money to your son tax free is to have him own the policy. Which means he has to make the payments, although you can gift him the money to do it with. You can probably set it up so you gift to a particular account that the premium is automatically paid from. But there's no guarantee he won't mess it up. Once the money is gifted you have no control.

Of course, if your estate is below the estate tax threshold there's no federal tax.

This is my understanding also, if you are doing the insurance approach.

-ERD50

 

[harley]

Well, I was just continuing the discussion to see if there is a hole in my thinking. I don't trust my own thinking, so I try to see if the smart people on this forum can challenge it and point out if/where I made a mistake. To me, that is different from 'arguing', but we all see things differently.

Sorry, shouldn't have said arguing. I meant that if you don't think someone is understanding your point you are very patient in explaining it as many times as needed. But on this one I think it's just another situation of agree to disagree. I hope/intend to have a healthy estate to pass on sometime in the (hopefully far) future. I'm going to look into the Ed Slott method as a way to minimize the tax bite. Maybe by then there will be better ways to deal with the situation.

But no matter whether people agree it's a good method or not, regarding the OP I don't think this can be classified as a scam.

 

[pb4uski]

I can understand how they could be used for liquidity in a case like this. I wonder if there aren't cheaper ways to go about it though.

But I still question its value as an 'investment'.

-ERD50

But in the case cited it is not an investment because the purpose for buying the insurance is not to ever cash it in, but to get the death benefit tax free to pay estate taxes when the owner dies so the family business doesn't have to be sold.

IMO, where whole life shines is where where one needs mortality coverage for a very long time.

I have a one whole life policy that I bought 34 years ago before I knew any better but have kept in-force because the monthly premium is minimal. Based on the CSV as of the last policy anniversary, the IRR has been 5.1%, not too bad for a relatively risk-free investment over 34 years and that doesn't even begin to consider the value of the mortality coverage that I had over the years that would have protected my family in the event I had an early demise.

While I'm not an advocate of whole life, if you have a really long time horizon and a long-term need for mortality coverage it can work out pretty well.

 

[dgoldenz]

Life insurance has been used to pay estate taxes for years, but less so recently because of the new $5M per spouse exemption. A guaranteed UL policy will maximize the death benefit for the lowest possible premium and is still guaranteed for life. If there are two spouses living, a survivorship guaranteed UL policy will be even less expensive.

 

[RetireBy90]

Well, I was just continuing the discussion to see if there is a hole in my thinking. I don't trust my own thinking, so I try to see if the smart people on this forum can challenge it and point out if/where I made a mistake. To me, that is different from 'arguing', but we all see things differently.

So arguing about arguing - hrmmm - sorry, I couldn't resist

However, on to the point about whole life as an estate planning tool. I've always understood it like Harley described, but I'm sitting here thinking, if I want to have a say $10M policy to pass along to my heirs, I'm thinking that on the whole I'm going to have to pay in a sum sufficient to amas say $10.5M before I'm supposed to die so that they insurance company has $10M to pay out and say $0.5M for overhead/profit. So would it not turn out the same if I put say $10K a year in a low cost fund or index every year in my heirs name(s) as the annual gift rather than putting it into paying the premiums for a policy? Wouldn't my heirs end up with the same $10.5M if they followed similiar AA as the insurance company?

No arguing here, just now I'm feeling confused on a topic I thought I understood.

 

[pb4uski]

So arguing about arguing - hrmmm - sorry, I couldn't resist

However, on to the point about whole life as an estate planning tool. I've always understood it like Harley described, but I'm sitting here thinking, if I want to have a say $10M policy to pass along to my heirs, I'm thinking that on the whole I'm going to have to pay in a sum sufficient to amas say $10.5M before I'm supposed to die so that they insurance company has $10M to pay out and say $0.5M for overhead/profit. So would it not turn out the same if I put say $10K a year in a low cost fund or index every year in my heirs name(s) as the annual gift rather than putting it into paying the premiums for a policy? Wouldn't my heirs end up with the same $10.5M if they followed similiar AA as the insurance company?

No arguing here, just now I'm feeling confused on a topic I thought I understood.

No, it doesn't work that way. It sort of works that way for the pool (all the people of your age and rating that buy policies in the same year that you buy), but not for any individual policyholder.

The premiums paid by others in your pool also contribute to the payment of death benefits as well as interest earnings on the premiums received in excess of benefits paid. So those who buy a policy and lapse help support the payment of death benefits for those who keep their policies.

 

[ERD50]

Sorry, shouldn't have said arguing. I meant that if you don't think someone is understanding your point you are very patient in explaining it as many times as needed. But on this one I think it's just another situation of agree to disagree. ...

No problem. Even I sometimes get to the point that the back-forth on a topic gets tiring, so I just drop out of the conversation.

That said, just ignore the following if you don't care to continue - but I really don't see this as something that two people could 'agree to disagree' on. It either is or isn't, regardless of either of our opinions.

But no matter whether people agree it's a good method or not, regarding the OP I don't think this can be classified as a scam.

Scam is a strong word. But I do think the insurance salespeople distort the case.

Life insurance has been used to pay estate taxes for years, ...

As is said, insurance is often 'sold', not purchased. Whether this is an appropriate use is questionable, just because there is a history of it. There is a pretty strong history of people being sold whole life, when they would have best been served by term (family bread-winners).

So arguing about arguing - hrmmm - sorry, I couldn't resist

Something like that

However, on to the point about whole life as an estate planning tool. I've always understood it like Harley described, but I'm sitting here thinking, if I want to have a say $10M policy to pass along to my heirs, I'm thinking that on the whole I'm going to have to pay in a sum sufficient to amas say $10.5M before I'm supposed to die so that they insurance company has $10M to pay out and say $0.5M for overhead/profit. So would it not turn out the same if I put say $10K a year in a low cost fund or index every year in my heirs name(s) as the annual gift rather than putting it into paying the premiums for a policy? Wouldn't my heirs end up with the same $10.5M if they followed similiar AA as the insurance company?

No arguing here, just now I'm feeling confused on a topic I thought I understood.

My point exactly. On average, how can that not be true?

It could still make sense for liquidity to pay estate taxes in some cases. Say $1M is needed to pay estate taxes for a non-liquid business. If the estate owner dies at a relatively young age, there would not have been time to move that $1M out of the estate. But the ins policy would supply the $1M in that case.

No, it doesn't work that way. ... So those who buy a policy and lapse help support the payment of death benefits for those who keep their policies.

True, but that would apply to anyone buying a LI policy. If that is a strong enough effect, it would make LI a good investment period. From that, it holds that we should buy it on groups of old people regardless of estate issues. But when I run the numbers, it does not seem like a good investment (as Brewer has mentioned).

-ERD50

 

[Tre2012]

Talking about two different things....

dgoldenz gave a short but very good explanation. But I guess there are still questions about this. I'm not an insurance agent, but have worked in insurance, banking and financial services as a back-office admin for 35 years so can understand the confusion. (BTW, if dgoldenz or anyone else thinks I've made a mistake in my explanations below, please correct me, thanks!)

This thread has diverged into two different avenues. Insurance is risk mitigation for MANY reasons, not just one or two as we are discussing here. Middle-class consumers think of life insurance as income protection because that is one of their biggest financial risks.

However, for the wealthy, income protection becomes secondary to estate tax planning. Because of the many current uncertainties about the estate tax laws, it's a subject of intense interest for the wealthy and their financial advisors. It's hard to make plans when you don't know what Congress is going to do (altho one can try to guess) or when they're going to do it. And estate tax law changes have been made retroactive in the past, making one's decision even more difficult.

So....if you are talking about income protection, the factors for how much you buy and what you buy, are very different than if you are talking about estate tax planning.

Income protection comes in the form of Term (either Level or Increasing), Whole Life, or Universal Life. Most people are focused on how much they're going to pay in premiums. Term is the most affordable because it has no cash value. If you are concerned about cash value, you are looking at insurance partially from an investment standpoint rather than face value protection.

You're the policy owner, so it's your choice. Just remember that insurers exact a heavy toll for cash value policies; you'll get less face value protection for your premium $$. A $100K policy, even tax free, makes for a puny drawdown at 4%. It should be noted that if you are the policy owner, the face value of the policy IS included in the total value of your estate at time of death, for estate tax purposes. It does, however, pass income tax-free to the beneficiary(ies), and is a Payable On Death (PoD) asset, therefore not under probate or trust control.

Estate Tax Planning for the wealthy most often uses Variable Universal Life (VUL) which optimally is held in an Irrevocable Life Insurance Trust (ILIT). Once set up this trust cannot be changed; it is a legal entity unto itself. Everyone has to follow all the IRS rules to the letter, or the trust will be disallowed. The insured(s) are NOT the policyowners but they do pay the premium, which varies each year according to the fluctuating market value of the investible portion of the VUL.

This premium allows the payers to remove excess after-tax cash from their estate, every year. Given that they may live 10, 20 or more years after setting up the ILIT, the total estate-taxable cash eventually drained off can be very substantial!

On one $5M VUL ILIT we set up for a young 40-ish couple who are Silicon Valley execs with substantial stock options, their initial premium was $22K for the first year. Although the start-up costs are substantial due to legal work, follow-up costs are relatively minor in succeeding years. Assuming nothing happens to them and they continue to fund the policy (they planned for a 10-15 year contribution period and to retire afterwards, leaving the policy able to fund itself), the face value may grow to substantially more than $5M, depending on how well the investible allocation does.

This allows them to be sure that no matter what Congress does, their son will have sufficient cash to offset the parents' estate tax hit, and he may well have extra non-taxable cash paid out from the policy if things go well. Remember, the ILIT is not owned by his parents, so it is not counted in the total value of the estate!

So you can see that these are two different scenarios, with very different numbers, because they are focused on achieving risk mitigation of two different goals. They are both life insurance-based, but they are "beasts of a different color", entirely.