Throughout its history, the life insurance industry has always produced creative people. From salesmen trying to position the product in a favorable light to home office individuals designing products that the field force can sell, the industry has always been rife with creativity.
In today’s low interest rate environment, once again the industry has come up with a creative way to increase the yields currently offered by the marketplace. This is accomplished by pairing a single premium immediate annuity (SPIA) with a life insurance policy, and is best explained by using an example.
The annual interest rate on most CDs today are still south of 1%, but even if they were double that, this concept would still work. In this example I will use a 75 year old female in good health who has $100,000 in a CD earning 1.5%.
First, the money in the CD is repositioned into a life only SPIA. This will generate $690.65/month, of which $666.48 is income tax free until the entire principal ($100,000) is recovered, after which time the entire $690.65 would be taxable. $690.65/month x 12 months equals $8,287.80/year, which equates to an 8.28% annual return ($8,287/$100,000 = 8.28%).
The major drawback of a life only annuity is that the payments stop when the annuitant dies, be that in year one or year 35. To hedge against an early death, a $100,000 life insurance policy should be procured, thus ensuring that the principal remains intact.
A $100,000 policy guaranteed to her age 120 carries an annual premium of $4,592, which, when offset against her annuity income, would produce an annual yield of 3.69% ($8,287 - $4,592 = $3,695, divided by the $100,000 = 3.69%).
To increase the yield, the guarantee on life insurance policy could be dropped from age 120 to age 95 thereby reducing the annual premium to $4,012 and thus increasing the yield to 4.27% ($8,287 - $4,012 = $4,275/$100,000 = 4.27%). This is just one example and the permutations of this concept are virtually unlimited.
As if this wasn’t good enough, there is another potential benefit to this concept. The value of the SPIA at death is zero, since payments cease at the death of the annuitant. So what was includible in her estate as $100,000 (the CD) is now zero. If estate taxes are an issue (and it only takes $675,000 in New Jersey to trigger the estate tax), then the life insurance should be owned by a trust, thus keeping those proceeds out of the estate.
A New Jersey estate valued at $1,000,000 will be subject to an estate tax of $36,560. A New Jersey estate valued at $900,000 will be subject to an estate tax of $30,960, thus saving $4,600 in taxes. Obviously, the larger the estate, the larger the tax savings.
This is intended as an introduction to the concept. If you would like more specific information, please call or email.