Most People Buy Overpriced Insurance
Would you buy an overpriced car? No. Yet most people (unintentionally) buy overpriced insurance.
Irvine Blackman, Brian I. Whitlock
Would you buy an overpriced car? No. Yet most people (unintentionally) buy overpriced insurance. Maybe a better way of explaining this wealth-building point is to say, would you like to buy a new car for a 40 percent discount?
What does a low price for a car have to do with real-life overpayment for life insurance? Well, let’s follow the money. Suppose you (as the owner of your business) put $10,000 into a 401(k) plan or other qualified plan. Assume the business is in a 40 percent tax bracket. Because the business gets a deduction for the contribution to the plan, it only cost you $6,000, because in effect, the IRS put in the other $4,000.
Let’s look ahead. Assume that after 10 years a total of $100,000 was contributed for your benefit. The cost to you as owner, after taxes, is only $60,000, and the current value in the plan for your benefit (after dividends, interest and growth in value of the investments) is $200,000.
Okay, you want to take some of that money out. Of course, after you reach age 70 1/2, you must start taking distributions. Now you must pay the piper back. Every dollar you take out will cost you a 40-cent toll charge (assuming you are in a 40 percent tax bracket).
What most people don’t know is that almost all qualified plans can buy life insurance in the plan on your life or second-to-die on your life and your spouse’s life. Yes, even a rollover IRA can join in the tax-saving fun.
For example, if your insurance premiums are $10,000 every year, you must earn $16,667 and pay an income tax of $6,667 to have the $10,000 left to pay the premiums. But wait—if your qualified plan pays the $10,000 premium directly to the insurance company (instead of you taking a $10,000 distribution), you save 40 percent (or $4,000) on each $10,000 you would have taken as a distribution from the plan.
What a great tax deal! When your qualified plan pays your premium, you save taxes three times: (1) when the money goes into the plan you get a deduction; (2) as the value of your plan account grows tax-free; and (3) when you use those plan dollars to pay a permitted personal expense such as life insurance premiums.
Substitute your own numbers. You’ll save enough to buy almost any car with the IRS’s money. Plus, there’s a bonus. Properly structured (using a subtrust), you can keep the life insurance proceeds out of your estate (saving 55 percent of the insurance proceeds under the current estate tax law).
The following real-life examples should get your tax-greed glands activated:
- A 64-year-old business owner has his profit-sharing plan pay a $24,486 annual premium for $1 million of life insurance.
- A 45-year-old man (owns 50 percent of a family business) and his 48-year-old wife have $3 million of second-to-die coverage. His 401(k) plan pays the entire $9,489 annual premium.
- A 58-year-old business owner (Joe) had $915,000 in a rollover IRA. Joe was paying annual life insurance premiums of $17,047 for $1.5 million of coverage on his life, and the policies had a cash surrender value (CSV) of $247,000. Joe no longer needed single-life coverage, but he needed more insurance. Here’s what we did: (1) Joe pocketed the $247,000 CSV (tax-free) and canceled the old policies; (2) The IRA was rolled back into a new profit-sharing plan in Joe’s company; (3) $6 million of second-to-die insurance (with Joe’s wife Mary, age 57) was purchased by a subtrust of the profit-sharing plan for an annual premium cost of $47, 985. The IRS will pay 73 percent of the premium while Joe and Mary create $6 million in tax-free wealth. Note: Joe did not buy a new car with his savings. He bought a boat.