By Katherine Vessenes, JD, CFP®, RFC
We have been privileged to assist many doctors with solving a key problem for them: How do they get more of their retirement money free of burdensome income taxes? For some we use Roths through a backdoor technique. For many we use a combination of Roths and Indexed Universal Life (IUL).
We like IULs, but the first thing we tell our doctors is that this product is complicated. In fact it is so complicated that we won’t let a doctor pull the trigger on it unless we have discussed the idea at three different meetings. The second thing we tell is that we like the product a lot, but it is not perfect. We want to make sure every doctor knows the pros and cons of this, or any other investment, before they move ahead.
Most of our doctors don’t know anything about the concept of tax-free income in retirement through life insurance products. Because of this, we take our time explaining all the pros/cons, expenses, rates of return, what can go right and what can go wrong, in addition to the fun part—estimates on how much money they might have in retirement that they don’t have to report to Uncle Sam.
Here are the top questions I get about this product:
1. What if the insurance company fails or goes bankrupt?
Typically when insurance companies get into financial trouble, another insurance company will buy them out and pick up all the contracts. Remember your policy is a contract, so the new insurance company is legally bound to honor the terms of the new contract.
If your company is not purchased by another, almost every state has a "guaranty fund" that handles life insurance company bankruptcies. This works like the FDIC that insures against bank failures. The guaranty funds will pay your claims, particularly for your cash value, up to a certain limit if your insurer goes under. In most states, the maximum aggregate benefit for all claims is $300,000 for life insurance policies.
The financial reserve requirements for life insurance companies is much higher than banks. That is why so many banks failed in the great depression, and by contrast, so few insurance companies met the same fate.
Finally, this is the reason we want to make sure we only deal with insurance companies that are financially strong.
2. Can I choose how to invest my money?
Actually the insurance company makes that decision. Here is how they do it: Let’s say your premium is $1,000 per month. The insurance company takes around $950 of that premium and buys an investment that guarantees they will get back $1000 at the end of the year. That is how they can guarantee that your cash value won’t lose money in a down year. With the other $50, they use it to buy options, specifically calls, and to purchase a particular investment if its price falls within a specific range. In good years, the $50 will provide some extra income—that is how they can get extra rates of returns on the product. In bad years, the options expire and there is no extra return for the policy owner.
3. What happens if I can’t make a payment, lose my job, or face some catastrophe?
That is one of the great things about this product—the premiums are flexible. First there are a band of premiums, set between a minimum and a maximum premium. Obviously the more money you invest, the better it will do over time. So one thing you could do is go to the minimum payment, and then as your life improves you can go back to a higher payment, or even dump in a load of cash if you get a bonus or sell your business.
Let’s say you have a year where you can’t make any payments at all. Depending on how long you have been in the product and how the market has done, that might be ok. We will run some illustrations for you and let you know where you stand.
We might run “bad case” scenarios for our doctors (note: we never call them “worst case” scenarios.) Depending on the doctor’s situation, we might show premiums paid for 10 years and then taking a 4 year break and resuming premiums, or just paying for 10 years and then stopping.
Within limits, we can also reduce the death benefit, which means more of their premiums will go to savings and less will go into the cost of insurance.
4. What if Congress changes the tax benefits?
These insurance products used to have even better tax advantages. In the past, the wealthy would put in millions of dollars so they could have tax-free savings accounts. The IRS got onto this tax strategy and passed a law that limits how much can go into these policies. However, all the lucky people who had been socking money away managed to have their policies grandfathered in and kept their tax benefits.
Nothing is certain, of course, but a general rule of Congress is to only make proactive tax changes. That would mean they are likely to grandfather in any existing policies.
5. Why aren’t more people doing this? Why haven’t I heard about this?
First, the best candidate for this strategy is a young and healthy person. The younger and the healthier the better, because the costs of insurance will be lower and they will get better returns over time. The best candidates also need to be good savers and willing to commit to a long term saving strategy.
The only doctors I have had who declined this product had no disposable income—they were living fist to mouth and couldn’t save anything. This is the wrong product for doctors who don’t have an emergency fund or a steady stream of disposable income.
Finally, most stockbrokers are not familiar with these products. They may not be licensed to recommend them or, due to their complexity, they don’t understand them. Many insurance agents can only recommend products that are manufactured by their insurance company. As a result they don’t even have access to the new products that are designed for tax-free income in retirement.
If you have any questions about Life Insurance in general, please reach out to us—we would be happy to answer them.
Katherine Vessenes, JD, CFP®, RFC, is the founder and CEO of MD Financial Advisors who serve 500 doctors from Hawaii to Cape Cod. An award-winning Financial Advisor, Attorney, Certified Financial Planner®, Registered Financial Consultant, author and speaker, she is devoted to bringing ethical advice to physicians and dentists. She can be reached at Katherine@mdfinancialadvisors.com.