By Paul Ferraresi
When purchasing a maximum funded, minimum death benefit (MFMDB) Equity Indexed Universal Life (EIUL) policy there are many factors that must be considered.
The professional that advises you on one of these special policies is thinking in the opposite pattern of a traditional insurance agent. You, and most insurance agents, have been programmed to spend the least amount in premiums to buy the maximum amount of insurance death benefits. That is a correct strategy if you are buying death benefits.
The objective of an EIUL policy that is MFMDB is to provide LIVING BENEFITS! The policy is established so you purchase the minimum amount of death benefits that the law allows while providing the maximum living benefits for you. When correctly structured these programs, using equity management, can provide a tax deductible non qualified retirement plan whereby you cannot outlive the income.
Some benefits to you:
- The contributions can be tax deductible
- Contributions grow income tax free (not tax deferred like IRAs/401ks)
- The money can be withdrawn income tax free
- When you die the benefits blossom and transfer to your heirs income tax free
Some other side benefits:
- The money in the account can be withdrawn for college needs. These amounts are NOTsubject to Financial Aid scrutiny. In fact, the value in these accounts are NOT considered for Financial Aid calculation when families apply to a college
- Account values and withdrawals are exempt from Medicaid calculations
- Monies can be withdrawn for nursing home or in-home care use and are exempt from Medicaid rules
How do these policies function?
There are strict government guidelines that determine the amount of minimum insurance that must be purchased for the monies being invested. (bucket size) These rules are covered in the tax laws “TEFRA” and “DEFRA”. The insurance amount required is based on many factors including age and gender. With the “bucket size” in hand, along with the minimum insurance amount, the next step is to determine how the program is funded.
These plans were so lucrative for policy holders, in the past, that banks and mutual funds lobbied Congress to shut them down because huge amounts of monies were flowing out of banks and mutual funds into EIUL policies. A shut down would be in violation of the anti-trust laws. Consequently, a compromise evolved in the tax law, namely, “TAMRA” that dictated how many years it will take to fund the “bucket”. The average time to fund is about 5 years. The dollars invested are placed in a liquid side fund (see Doug Andrew’s books Missed Fortune, Missed Fortune 101, and The Last Chance Millionaire for a detailed explanation).
The best illustration of how this program works is to envision owning a 5 story apartment building. Each floor symbolizes one year of the policy premiums.
When you rent out the first floor the income is not covering the entire building’s costs. This is true for the second and third floor. In fact, at the 3rd floor (3rd year of policy contributions) you are probably just breaking even. Once the 4th and 5th floors (4th and 5th year of policy contributions) are rented, then, you are seeing a positive cash flow. The annual gains now are retroactive back to the first day of ownership.
How are your premium payments distributed? Upon receipt of your premiums the insurance company will position your funds as follows:
1. Policy administration fee: Companies will charge $10-$20 per month. These fees are subtracted at the beginning of the year and held in escrow and then deducted monthly.
2. Premium load: These fees are for marketing, investment management, and other charges. The average cost is about 5.5% of premiums. These amounts are deducted only at the time of a premium payment.
3. Cost of Insurance (COI): The company determines the mortality costs, deducts this annual amount up front each year, holds it in escrow, and, withdraws it on a monthly basis. This amount varies based on your age, gender and amount of minimum death benefit.
Regressing, your gross premium dollars are received by the company. The fees and costs listed above are deducted leaving a net amount to invest. These net amounts are held in a low-yielding guaranteed income earning account until “swept” into your investment choices.
Companies have different “sweep days”. Some companies will place your monies on the 15th and 30th of each month. Other companies have a quarterly sweep date, say, the 15th of February, May, August, and November. If you miss the quarterly sweep by one day, then, your monies will sit in an interest earning account for the remainder of the quarter until swept in. The same concept holds for a monthly or biweekly sweep.
With these factors in mind let’s look at the first year of your program:
The policy is issued, say, on May 20th. You complete the policy delivery receipt papers and make payments on June 10th. If your company does a sweep monthly on, say, the 15th then your monies will make the June 15th deadline, otherwise, you wait until the next sweep date. If your crediting strategy is a 1 year point to point, then, your return will not show on the following year May 20th anniversary report since monies were invested June 15th for 1 year. In fact, the report will look grim on May 20th, in that, it shows the premiums paid, all the expenses explained in number 1-3 above deducted, and, no returns since your return crediting does not show up until the following June 15th. We suggest, and schedule, an annual review only after the return is credited.
In years 2-5 or 6, your premiums are paid. The monthly administration fee stays constant (it is fixed) at say $10-$20 per month for the life of the program. The premium load is deducted only for the years of your contribution. The cost of insurance will be charged for each year the program policy is in force.
To better understand the three major policy expenses let us use the rental building analogy.
1. The monthly policy fee is like paying the building’s monthly utility bill. This will continue for the time a property (or your policy) is owned.
2. The premium load would equate to paying the real estate broker’s leasing fee. The majority of these fees will be while we are “leasing up the property” (making our premium payments).
3. The cost of insurance, equates to the building management fee, in that, it will continue for as long as we own the property (or your policy).
Naturally fees and costs vary by company. In the first 3-4 years of the policy, the goal is to reach breakeven (similar to the leasing up of the building). In years 5 and 6, and thereafter the policy (the building) starts to cash flow.