VULs, Annuitys, Roths, and other things

MysticLlama · 03-07-2007, 05:51 PM

Okay, so I went to see a financial guy last night, and we sat and chatted about various things that I can do to save, plan for the future, etc.

The one obvious decision was to not cut back anything on my 401k since I put in 15% and it gets matched 25% on the full amount. Can't do better than free money.

I have a little bit in a Roth, and he pointed out the 5 year period to not take anything out or else rick converting it to a taxable event (can't remember the term right now). Not a big deal since I plan to leave the stuff in there for a long long time.

Then we looked over the VUL, he didn't have any specific company, talked about different sorts of options, etc.

After doing some research, I can see how it'd be a really bad thing. The fees are way higher than normal life insurance, the return isn't always so great, etc. But... it gives me a window by getting into it at a lesser rate now, being 28, and while it wouldn't be a good investment for me in the short term, if I kept it for 10+ years, after that point I already have it in place, can use it to put in money and keep it tax deferred, and have the fee schedule locked in from being young.

Once the money is in there, you can take it out as a loan, tax free (though you lose the possibility of that portion appreciating) at net 0% interest, and it doesn't have to be paid back until death or the contract is nullified. This essentially makes it tax deferred and tax free, in theory.

So what is the big giant catch that I'm missing? I'm aware that tax law could change a bit and make the savings not as worthwhile. I'm also aware that the fees could kill me if I don't keep it for a really long time. What else is there?

There were also a couple of pretty neat options for annuities, but maybe that's another thread, I already wrote a book.

competentone · 03-07-2007, 06:47 PM

Quote:

Originally posted by MysticLlama
After doing some research, I can see how it'd be a really bad thing. The fees are way higher than normal life insurance, the return isn't always so great, etc. But... it gives me a window by getting into it at a lesser rate now, being 28, and while it wouldn't be a good investment for me in the short term, if I kept it for 10+ years, after that point I already have it in place, can use it to put in money and keep it tax deferred, and have the fee schedule locked in from being young.
.

Do a little math. Look at what you can buy term life insurance for and compare what you're paying when buying universal life.

Additionally, ask yourself why you need life insurance -- most people need life insurance to take care of their children. As you grow older and build wealth -- and after your off-spring grow up -- the need for life insurance simply disappears.

The selling point of being "locked in" at a low rate because you are young is the BS. Buy a 10 or 20-year term life insurance policy when you need it and do your savings/investing without the middleman taking his huge cut.

competentone · 03-07-2007, 06:51 PM

Oh, and if you can afford it, max out your contributions to your Roth every year. Put it in a brokerage account and invest to your level of risk tolerance.

The compounded gains the Roth offers -- without the government taking their cut every time you make a profit -- is fantastic.

MysticLlama · 03-07-2007, 09:32 PM

The basic point of this isn't the life insurance, I think that's where it becomes a little more interesting.

Essentially, you can put funds away into it like a Roth, but a larger amount than a Roth allows. Then you later take out the loan, not to be paid back until the contract terminates (death if you keep it forever)

So you don't pay the taxes on the withdrawls like you do with a Roth, which makes it tax deferred, as well as free.

That's the part that makes me wonder how long these can possibly go without getting tax laws changed on them.

The life insurance in the end ends up being a very small portion when compared to the possible tax savings over the long term.

This of course only works with fairly significant sums of money and lots of time. I don't have the first right now, but plenty of the second.

competentone · 03-08-2007, 07:02 AM

Quote:

Originally posted by MysticLlama
So you don't pay the taxes on the withdrawals like you do with a Roth, which makes it tax deferred, as well as free.

That's the part that makes me wonder how long these can possibly go without getting tax laws changed on them.

I'm not sure what you're looking at, but the IRS normally considers transactions made solely for the purpose of avoiding paying taxes to be illegal tax shelters. (Yesterday's or Tuesday's Wall Street Journal had a good article about "myCFO" and how it was just a tax shelter.)

Additionally, with a Roth you do not pay taxes on your withdrawals. If you quality to contribute to a Roth, you put in dollars you have already paid the taxes on, let it grow tax-free, and withdraw during your retirement without paying any taxes. Additionally, you can take the dollars you have contributed out without any taxes or penalties prior to your retirement if you choose.

Billbo · 03-08-2007, 07:26 AM

I believe you would owe taxes on any gain in the contract, your basis (premiums paid over time) has already been taxed.

hytem · 03-08-2007, 07:43 AM

As far as I understand it, with all these IRAs, you have to pay taxes on them--whether going in or going out. Which way is better for you depends on your tax situation. I like to get a tax credit right up front on the traditional IRA, and can withdraw anytime since I'm over 59 1/2. I'll pay the taxes later when my income drops, or when I'm no longer around to pay taxes.

There are so many of these IRAs, now, you wonder how the government keeps track of them.

tc-sacto · 03-08-2007, 08:06 AM

There are no taxes on the VUL beacause the money is taken out as a loan. You need to calculate the after-tax return net of fees for "buy term-invest the difference vs. VUL strategy. The VUL could be a good alternative if the numbers work out.

Also, if available to you, and depending on you tax bracket the new Roth 401k could be a boon for a young person. Use this first max out to the toon of $15,500 at the current allowable deferal rate.

So in preferred order
1) Roth 401k $15,500
2) Roth IRA $ 4,000
3) VUL if the numbers work out and you can save this much anually

Billbo · 03-08-2007, 08:57 AM

Here's the But: The loan will be paid back, either while your you're alive, at the time of death or at the surrender of the policy. Taxes on the gain will be paid, no free lunch. The insurance company will not loan out more than you have in built up cash value (equity). Your death benefit will be reduced by the amount of any outstanding loans. Buy life insurance for the death benefit, never as an investment vehicle. Buy term (if you need the coverage) and invest the difference.

tobster1911 · 03-08-2007, 09:15 AM

I was looking at this exact same thing last year. I am 28 as well and I decided that the VUL is NOT worth it. The price difference for the universal life vs. term life was a LOT. So they say, well you have a fixed rate and you are gaining monetary value and that is why it is better. Last they say it is completely non-taxed.

You can get a 20yr term policy with a good rate and that would take you until you are almost 50. This means (potentially) that your kids are grown and out of the house. Only your wife is left. Unless you want to use this as a means to leave an inheritance (not the best way) it does not make sense to have a large life insurance policy.

As for gaining monetary value as a savings vehicle, just remember that the first ~5yrs go to commissions and the insurance co. I have all the numbers for the plan I was looking at and it would take 10yrs for it to really start some serious growth. This is because the principal in the account does not have enough mass (due to the majority of the premium not going to cash value) until 10yrs from the start. You can do just as good or better by taking that $diff UAL vs. TL and putting this completely into a ROTH or even a mutual.

ROTH investments use AFTER tax money so they too can be withdrawn tax-free after retirement.

MysticLlama · 03-08-2007, 09:23 AM

I have come to some of the same conclusions myself, I was kinda curious if there was anyone it *was* working for, and that doesn't seem to be real common after asking around.

I do realize the fees and such are quite high at the beginning, the plan would be to pre-fund it heavily the first couple of initial years to make the curve better.

I do realize the tax gets paid later, but it basically ends up in the end that if you take a bunch out , the insurance covers the gap and the taxes and the thing just kinda goes away. This doesn't leave anything to pass down, but that's not really how I'd want this to work anyhow, there are better ways to do that kind of thing I think.

I haven't got an actual plan in my hands yet, but I'll definately do all the math for a long term situation vs. funding a regular Roth instead.

tc-sacto · 03-08-2007, 09:40 AM

Usually the teqnique would only work if you use a Low or No load policy. You probably won't find this offered through an advisor. Vanguard Instituional has one available. No upfront load, no surrendar charge. M/E is about .4% Fund expenses are about .4% so total expenses are can be fairly low.

Looks like your doing your homework, Keep it up.

PS.
We usually only see this teqnique used for special circumstances, and for wealthier individuals. Not for everyday use.

tobster1911 · 03-08-2007, 09:43 AM

Quote:

Originally posted by MysticLlama
I do realize the fees and such are quite high at the beginning, the plan would be to pre-fund it heavily the first couple of initial years to make the curve better.

I spent a long time trying to push different scenarios around with them. In the end, they are not going to let you swing the odds into your favor very much.

I tried to see if they would let me do a small UL and a large TL until the "fees" were taken care of and then convert the TL to the UL. This would be good for you because you could lock in rates that are not cancel-able. No good. They start you back over with the fees and commissions. Also they would not give you the fixed rate. The only benefit they give for doing this is that you don't have to requalify.

The only relatively "good" option would be to dump in a HUGE lump in the first 1-2 yrs. This would pay them off and then you could focus on growing the value. The problem is that unless you structure the UL payout to grow with your investment gains, the amount that your investment makes gets subtracted from the policy amount and they only pay the difference. So by your money making money, you help them pay less. Nice, nice for them....

Billbo · 03-08-2007, 09:56 AM

Another snag is that the companies have a limit on the amount of money you can put into these contracts. Go over the limit and it is no longer considered life insurance by the feds. The days of huge payments into these policies are over.