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Permanent Life Insurance: Commission vs. Cash Value

Permanent Life Insurance: Commission vs. Cash Value

February 12, 2018
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When working with many of our high net-worth clients, often the need for permanent cash-value centric life insurance may be recommended. Every client’s situation is different, but it may be a viable option for you, depending on what you are hoping to accomplish. If through the planning process, it is determined that a permanent life insurance policy, such as Whole Life or Indexed Universal Life, there are some very key things to ask and look for if maximizing the cash value is the number one priority.

Before we jump into the questions to ask regarding cash-value life insurance, lets jump into a little bit about the differences in the kinds of life insurance and what kind you should get.

This is one of the most hotly debated topics in the financial planning/risk management world. “What kind of life insurance is best?” I will jokingly answer this questions with: “The kind that was in-force when you died. That was the best kind to have.”

So many so-called financial experts like to throw down their opinion as gospel and tell you that one kind of life insurance is ALWAYS the answer or to avoid another type of life insurance like the black plague. Nothing could be further from the truth. Because IT DEPENDS!!

It depends on your personal situation. It depends on your financial situation. It depends on your goals and objectives. It even depends on how financially successful you currently are, or how financially successful you think you will become.

Nothing gets me more frustrated than on-air pseudo “financial experts” telling the masses how they need to protect their family and their future, when these people have never done a deep dive into your personal situation. Don’t take your financial/risk management advice from the radio. Meet with someone you trust and has your best interests at heart.

Now… that we have addressed that, let’s define the various kinds of life insurance:

  1. Term Life Insurance: If I were to compare Term Life Insurance to anything I would compare it to “rent.” You “rent” coverage or protection for specified period of time. If you happen to die during that “rented” time period, the insurance company will pay your beneficiaries the death benefit outlined in the life insurance policy.

Typically, at the end of the “rental” or term period, the policy will simply expire. Some term policies will annually renew at the end of the term period at a much higher premium, that increases every year they renew

Term life insurance is often the least expensive way to ensure you have life insurance protection, especially when you are younger. It is typically the cheapest way to make sure that your family or business is protected against a premature death. It helps make sure your family business is able to continue forward with minimal interruption.

The main downside associated with all types of term insurance is that premiums increase every time coverage is renewed. The reason is simple: As you grow older, your chances of dying increase. And as the likelihood of your death increases, the risk that the insurance company will have to pay a death benefit goes up. Unfortunately, term insurance can become too expensive right when you need it most — in your later years.

Term insurance is typically sold in 10-, 15-, 20-, or even 30-year level term periods. Several variations of term insurance do allow for level premiums throughout the duration of the contract.

  1. Permanent Life Insurance: The 2nd type of life insurance is permanent life insurance. Now, there are many different variations of permanent life insurance, such as WL, UL, IUL, and VUL. But today I am going to talk in more broad terms and just lump them all together as permanent life insurance.

So, using the same example I gave regarding term insurance, and comparing it to “renting” coverage, permanent insurance can be compared to “owning” coverage. Typically, you are going to pay a bit more premium for the permanent life insurance, but as long as you pay that required premium, you will be covered for your whole life.

Now, over time, as you continue to pay into your permanent life insurance, your policy will begin to develop what we call a “cash value.” This cash value will grow tax-deferred and can be accessed tax-free to help supplement retirement, or assist in any other financial need you may have.

Now if you ever sit down with an advisor and they tell you that Term is always better than permanent or that Permanent insurance is always better than term, I would simply gather your things and leave… because IT DEPENDS. It depends on your exact situation and what you are trying to accomplish with your coverage and with your money.

Once you go through the planning process and you and your advisor have determined that permanent life insurance, whether that be Whole Life or Universal Life, is suitable for your exact situation, there are some tips and tricks that should be followed if you want to maximize the amount of tax-favored cash value that can be potentially credited to your policy.

Now I want to let you into some of the secrets of the life insurance process and tell you generally how a life insurance agent or financial advisor is compensated for placing a life insurance policy. Typically, the amount paid to an advisor on life insurance it tied to the amount of death benefit and the target or annual premium. The higher the death benefit and the higher the annual premium, the higher the commission that is set to be paid to the advisor.

I don’t want to give you the impression that an advisor should not be compensated for the work that they do for recommending a life insurance policy in your financial plan, because it is a vital piece of your financial life. But, I do want to illustrate to you the importance of working with an advisor that has your best interests at heart and I want to educate on how to make sure that the permanent life insurance policy is set up correctly to MAXIMIZE the cash value, IF that is the ultimate goal.

Let me run through a couple of examples. Let say that we have a 40-year-old, Preferred Plus rated, male. This is someone who is generally healthy and does not smoke. With life insurance a lot of the costs of insurance can be based upon the health and lifestyle rating of the insured individual. This gentleman is looking to put $75,000 per year towards his cash value in his life insurance policy to help fund his buy/sell agreement policy AND provide him an executive bonus-type income plan that will aid in funding his retirement. A buy/sell agreement is a document that business partners draft in order to resolve financial issues that could arise from a death, a disability, or even a dissolution of the partnership or company.

There are two basic ways this policy can be set up. I will run through both ways, and explain to you the compensation that could be paid to the advisor in both scenarios.

If an advisor is looking to maximize the amount of cash value the policy is hoping to accumulate inside of their life insurance policy, they will strive to maximize the death benefit and therefore have the majority of the premium going towards the cost of the actual insurance.

For example,

  1. The advisor would set up the indexed universal life insurance policy with a base premium of $75,000/annually. This would buy approximately $9.8M of death benefit. The advisor is trying to maximize the amount of death benefit being purchased for the $75,000. The issue with this is, in our example, the client wants to maximize the CASH VALUE, not the death benefit. The cash value crediting rate is then based upon a crediting strategy that is based upon an index, such as the S&P 500. If the index value goes up, the owner of the policy is able to participate in those gains. If the index value goes down in a given 12-month period, then the owner is still credited the guaranteed rate of the policy, which could be at least 1% per year.
    1. If the client continues to pay $75,000 for 20 years into this permanent life policy, and let’s assume the gross crediting rate of the policy is 6.92%, the cash surrender value at the end of the 20 years could be approximately $1,675,698, giving you an IRR of 1.04% on the cash value. Not real exciting… except for the advisor that set it up.
    2. Setting a policy up in this way could potentially pay the advisor approximately over $100,000. Now, like I said before, I am not against advisors being paid what they are worth, but I do have a problem if they are being paid more at the expense of the client. If the client’s number one priority is cash value, there are far more efficient ways to set up the policy.
  2. Now, for the advisor to maximize the cash value for the client, you need to focus on how much of the your $75,000 is going to pay for a death benefit and how much will goes toward the cash value. With every permanent policy, a certain amount of the premium is set to cover the actual costs of the insurance… the death benefit. Then another portion of the premium can towards the cash value growth. What you want to do, in order to maximize the cash value and keep the cash value as tax-favored at withdrawal, you need to have the policy structured in such a way that you try and purchase the LEAST amount of death benefit for $75,000. That way the majority of your money goes to the cash value and not to pay for a death benefit you may not need.
    1. To show the contrast of how the cash value behaves in this scenario, let me show you the example. When we set this policy up, we tell the insurance company, “what is the least amount of death benefit I can buy with $75,000 to keep the cash value tax-favored?” In the example of the 40-year-old, Preferred Plus male, that death benefit amount is just over $2,000,000. On the surface you may say, “That is expensive life insurance!” But what is happening behind the scenes is, the majority of your $75,000 is going to the cash value. If the client needs more than a $2,000,000 death benefit, then the difference can be made up with inexpensive term insurance.
    2. If the client continues to pay $75,000 for 20 years into this permanent life policy, and let’s assume the same gross crediting rate of the policy is 6.92%, the cash surrender value at the end of the 20 years could be approximately $3,057,305, giving you a tax-favored IRR of 6.38% on the cash value. The same $75,000 going into the policy as the first example, but because that premium isn’t paying for a large death benefit, more of your money is being credited to your cash value.
    3. Setting a policy up in this way could potentially pay the advisor approximately $22,000. If cash value is paramount and the advisor has the best interest of their clients at hand, then could be the proper way to set the policy up. $100,000 vs $22,000, you are paying for the additional compensation to the advisor at the expense of your future cash values.

When working with an advisor that is implementing cash value focused life insurance, you need to make sure that it is being set up correctly to maximize your cash value, not the advisor compensation.

Here at Redstone Financial Group, we are focused on our client’s maximizing the money they are putting towards their financial plans so that they can be as efficient as possible. We employ our propriety planning model known as the Retirement Efficiency Matrix. That tries to be fee-conscience and tax-efficient.

If you would like some help with the structuring of your life insurance plan or firm buy/sell agreement, we can schedule a phone call to discuss a game plan that is right for you. You can do so by clicking on the “Schedule Now” button below and grabbing your slot on our calendar.

The example given is purely hypothetical and individual results/rates will vary.