We look forward to the Van Mueller newsletter every month. It's chock-full of sound bites, sales tips, and eye-opening statistics. Here are our favorite parts of the May 2019 edition. We're sharing the full introduction, and 2 of the 7 monthly sales ideas. If you like what you read, we encourage you to click here and become a subscriber.
Reprinted with the author's permission.
No time to read? Watch our video overview:
May, 2019 – 7 Ideas and Views Newsletter by Van Mueller
Buy term and invest the difference. Life insurance is a lousy investment. I hate annuities and so should you. I tried to get my broker dealer to allow me to take out an ad that said, “I hate Ken Fisher and so should you.” They wouldn't let me. No one can time the market. You should contribute to the match in your 401(k). You should never tax defer with an annuity, but you should always tax defer with an IRA, 401(k), 403B or 457 plan. Here's the big one. You should never, ever MEC a cash value life insurance policy.
Are you aware that none of the previous statements are even in the vicinity of being accurate? The biggest inaccuracy is that you should never MEC a policy. I disagree. What if this is the greatest time ever to use MEC's as a tool to help the American people deal with a number of challenges that they will be faced with in the years ahead?
That's what I am going to write about in this month's tutorial. We will review what a MEC is, and how it is taxed, how we can use it to serve the American people and finally why this is the greatest time ever in the history of our business to write MEC's.
This is the greatest time ever in the history of our business to write MEC's.
What is a MEC? MEC stands for Modified Endowment Contract. In section 7702 of the Internal Revenue Code it is actually described as “Investment Life Insurance.”
There is an easy way to understand and explain to our prospects and clients what a Modified Endowment Contract (MEC) is, what it does and how it is taxed.
The simplest way to explain a MEC is that while the customer is alive a MEC looks, acts like, is taxed like and penalized like an ANNUITY. We will discuss what that means in a minute. At death, a MEC is treated like a life insurance policy. That means that the death benefit is paid to the beneficiary or beneficiaries income tax free.
Let's start with how a MEC is taxed while you are alive. Remember, it is income taxed exactly the same way a non-qualified annuity is taxed. Annuities are taxed “last in first out.” So are modified endowment contracts. That means you must always take out the interest it earns or the gain first, so that it can be income taxed. If there is no gain, then you may take out principle which is not income taxable.
A non-MEC cash value life insurance policy has several ways to access the cash value. You are allowed to take “first in, first out” withdrawals or loans, neither of which are income taxable. We have been so conditioned as insurance and financial professionals to believe that the only way to use a cash value life insurance policy is as a non-MEC that we do not pay enough attention to the actual tax law itself and the interest rate environment we are currently in. That prevents us from taking advantage of all the benefits that can be provided in particular by single premium cash value life insurance policies which are also called modified endowment contracts, MECs.
We have been so conditioned as insurance and financial professionals to believe that the only way to use a cash value life insurance policy is as a non-MEC that we do not pay enough attention to the actual tax law itself and the interest rate environment we are currently in.
May I please give you an easy example of how a MEC works and then a little more complex example?
Let's say you have a customer or a prospect who is over age 65 and has around $30,000 of Social Security. By the way, why do I usually use $30,000 as the income for Social Security? Because that is currently the average amount of Social Security that couples in America receive. Let's also assume that my couple have $20,000 per year of totally taxable pensions. Let's finally make one last assumption. Let's assume that my client has $200,000 of non-qualified money in a savings account, CD or money market earning one percent. This is a perfect client for a modified endowment contract (MEC). Why?
Think about this: Ask them how much money they absolutely must have in the bank. Most people will say $20,000 to $50,000. Let's assume our client says $30,000. I would then ask this question. What if I could make the remaining $170,000 look like $340,000 and you would have almost complete access to the money and you would earn approximately the same as you are currently earning on that money, would you move the money into a strategy like that? If the money was safe and you could access it at any time to take advantage of investment opportunities or you could access the funds to pay for long term care or assisted living wouldn't that be wonderful? If you didn't need the money for long term care or assisted living, wouldn't it be awesome that you didn't waste the money on premiums for something you didn't use?
If you didn't need the money for long term care or assisted living, wouldn't it be awesome that you didn't waste the money on premiums for something you didn't use?
Let's look at the federal income tax implications in two different scenarios. Let's say our account earned one percent. After four years in our MEC an investment opportunity presents itself and we want to temporarily use a good portion of the money in the MEC to take advantage of that investment opportunity. If our MEC earns one percent for four years, the gain would be approximately $7,000.00. If I wanted to temporarily borrow $150,000 of the $177,000 of cash value what would be the tax? Remember we started with $170,000 and our MEC earned $7,000 in those four years.
If you are over age 59½ what would the tax be? To be completely accurate I will use a 65-year-old. For 2019 the standard deduction is $27,000. Remember our client has $30,000 of Social Security and $20,000 of fully taxable pensions and now has $7,000 of taxable gain when they temporarily borrow that $150,000 of cash value from their MEC. The $20,000 of pension and the $7,000 of gain will cause $5,000 of their Social Security to be income taxable. Here's the math.
|Taxable Portion of Social Security||$5,000|
|Fully Taxable Pension||$20,000|
|Taxable Portion of MEC Withdrawal||$7,000|
If the standard deduction is $27,000 you subtract that from the fully taxable $32,000 leaving $5,000 taxable at 10 percent. Why 10 percent? That is the tax bracket you fall into if you have $5,000 of taxable income. 10 percent of $5,000 is $500. I temporarily borrowed $150,000 from my MEC and it only cost me $500 in federal income tax to do that.
You keep seeing me use the word “temporary.” I even make up a rule that I follow. The Van Mueller rule of 12-15. When they use the money for investment purposes they must stay in the investment for twelve months and a day, so they qualify for preferential income tax treatment called long term capital gains. If our customer qualifies for long term capital gains and they are married filing jointly they pay 0 income tax if their income remains under $104,000 with the gain. If their income is between $104,000 and $497,900 they pay 15 percent and over $479,000 they pay 20 percent. WOW! The 15 in the 12-15 rule says that they must pay back the loan before 15 months have expired because we don't want anything to happen to this foundational policy called a MEC that we are using in our strategy. Often times the client will use the gains they have made to buy another MEC. The next time an opportunity presents itself then we would withdraw money from both MECs to take advantage of the opportunity. Once you pay the money back on the $150,000 loan you took out, the new basis for that MEC becomes $177,000 because you have already paid taxes on the $7,000 gain. If you understand, another three or four years can now go by with little or no income tax liability to use the money.
Another three or four years can now go by with little or no income tax liability to use the money.
Now, instead of using the money to take advantage of an investment opportunity let's use the money to pay for a nursing home. Remember we used $170,000 to pay for $340,000 face amount modified endowment contract (MEC). We spend the last two years of our life in the nursing home as a private pay patient and we have to use $75,000 per year of the cash value of our policy or $150,000 and then we die.
If the customer had never met us they would only have $20,000 left of the original $170,000. However, because they met us will we subtract the $150,000 they used for long term care from the $170,000 they gave us or the $340,000 face amount? Won't it be the $340,000 face amount? Ask your customer if they realize how smart they are? Ask them if they understand that they could use 80 percent of their money for themselves while they were alive and the day they die, using this strategy, they have replenished all the money they started with income tax free. Wouldn't that be amazing? Ask them what would happen in our country if everyone used a strategy like that? Wouldn't we be able to solve a lot of problems? By the way, I just asked for a referral without asking for a referral because of the way the question is asked.
Ask them if they understand that they could use 80 percent of their money for themselves while they were alive and the day they die, using this strategy, they have replenished all the money they started with income tax free. Wouldn't that be amazing?
Finally, would this example have to be used only for nursing home expense? Couldn't this be a way to hedge against inflation? Wouldn't it allow families to use their cash value to supplement income and still leave behind at the very least, the money they started with? The examples and opportunities are only limited by your imagination.
Now, let's use an example of someone under 59½. Let's say age 55 and they are a married couple filing jointly.
They earn jointly $70,000 per year of income and have the same $200,000 of non-qualified money in a savings account. The MEC earns the same as our couple over age 65 and after four years an investment opportunity presents itself. What would be the income tax consequence if our couple owned a MEC?
|Taxable Amount from $150,000||$7,000|
|The Standard Deduction||$24,400||$0|
|The 10% Tax Bracket||$19,400||$1,940|
|The 12% Bracket on the Remaining||$32,200||$3,984|
What this shows is that the tax on the $7,000 that is taxable from the MEC is $840 ($7,000 x 12 percent). The penalty is $84 or 10 percent of the $840 because our customer is under 59½ and there is a penalty for touching this money before 59½. So to access and use their money for the investment opportunity only costs $924 of income tax. Remember, they are still covered for $340,000 and when they pay the loan back their new basis will be $177,000 because they have paid taxes on the $7,000 gain already.
To access and use their money for the investment opportunity only costs $924 of income tax.
My modified endowment contract has additional benefits. It does not have to go through probate if a beneficiary is named. The beneficiary is incontestable and private. It is even possible to control this money from your grave. This policy has creditor and predator protection. And finally, this asset can be converted from an asset into an income stream possibly preserving some of the benefit for the family.
Ask your prospect or client if they know anything else in the world that can do that?
Would a MEC be a more effective and efficient use of their money than a savings account, money market account, CD, checking account or short-term bond fund? By asking them questions you help them to reason out why a modified endowment contract (MEC) would be the appropriate choice. They use their own common sense to arrive at the best solution.
Let's review. Remember, a MEC is not just beneficial as a legacy benefit. Please think of it being used to offset inflation. It will replace benefits lost to a nursing home or assisted living circumstance. It will position money for investing that cannot lose but is available to take advantage of opportunities like stock market crashes.
For prospects and clients looking to pass a lump sum of money to their children, wouldn't a single premium life insurance policy be a better alternative than a CD, savings account, money market account, checking account or short-term bond fund? Wouldn't it even be a better alternative than even an annuity? Most people don't want to give the money to their children while they are alive, just in case they need it before they die. This not only preserves the benefit, it leverages it. What a concept.
Most people don't want to give the money to their children while they are alive, just in case they need it before they die. This not only preserves the benefit, it leverages it. What a concept.
Many of the new policies can even be sold with critical illness or chronic illness benefits. These benefits again leverage the money for multiple uses rather that the single use of a savings account or CD. You can even use a single premium life policy to provide retirement benefits. Depending on our clients' tax bracket and the current tax environment, we would still pay little or no income tax even if the benefit from the single premium life policy was fully taxable.
Let's remind ourselves about several considerations concerning Modified Endowment Contracts (MEC's).
Loans for MEC's should be for only short periods of time. Remember the rule of 12-15. Loans should be paid back by the end of the 15th month. The interest that is accrued to the loan will also be treated as current taxable income from the policy as long as there is a gain and will be subject to income taxes and penalties if the client is under 59½ even though the money is not withdrawn from the policy. Why is this still not a concern? Interest rates continue to be historically low, so the interest paid should be relatively low. Please also remember that withdrawals that are taken in excess of gain reduce your basis in the life insurance contract. When you repay the loan that repayment adds to basis, so you don't have to pay taxes on the same money again.
Please also remember that withdrawals that are taken in excess of gain reduce your basis in the life insurance contract. When you repay the loan that repayment adds to basis, so you don't have to pay taxes on the same money again.
The federal government will classify an overfunded life insurance policy (one that has more premium being paid that is required to guarantee cash value and death benefit to age 121) as a modified endowment contract (MEC).
While the customer is alive, the MEC provided tax deferred growth of the cash value and requires that all gain must be withdrawn first just like an annuity. Also, just like an annuity, there is a premature distribution penalty of 10 percent from any withdrawals made before age 59½. Remember, penalty and taxes only apply to gain. There is never any income tax liability on the original investment.
The saving grace of a MEC in comparison to an annuity is that the death benefit is paid income tax free. An annuity creates a taxable event for the person inheriting the money. This provides thousands and thousands of dollars of income tax savings.
The most common use of a MEC would be for clients who typically hold their assets in CD's, savings accounts, money market accounts, checking accounts, short term bond funds or fixed interest deferred annuities. They do not want to be exposed to any risk of principal. MEC's primary purpose allows for maximum cash accumulation and the maximizing of the amount of after-tax money that can be transferred to beneficiaries. There is currently $13 trillion dollars of this kind of money available for single premium life insurance policies.
We forget that Americans are much more concerned with loss than they ever are at missing out on gain. Even after a 10-year bull market, Americans desire safety more than gain. Study after study verifies this contention. We don't make people rich, we prevent them from ever being poor.
We don't make people rich, we prevent them from ever being poor.
What a spectacular and timely vehicle a single premium life insurance policy is. It has as many uses as you can possibly imagine. We can help our clients deal with ever increasing challenges by reallocating and repositioning ineffective and inefficient money to a more efficient and effective purpose while still maintaining access to the money for our prospects and clients.
One final caveat: Isn't it true that sometimes our clients can not qualify for a life insurance policy? This is happening less and less; however, it is still happening. Wouldn't it be smart to talk about all the spectacular advantages of an annuity with this customer first? When our customer agrees that an annuity sounds pretty good and they want to buy the annuity couldn't we use a transition sentence to explain a cash value single premium life insurance policy? We could then explain that it enjoys all the same benefits and opportunities of an annuity except that it is more liquid and has a tax-free death benefit and access to valuable riders not available with an annuity. May I explain a few of its additional benefits?
Many agents complete both an annuity and a single premium life insurance application. If for some reason the customer is uninsurable there is less chance of hurt feelings, you have benefitted this customer in either circumstance.
THIS IS THE GREATEST TIME EVER TO SELL MODIFIED ENDOWMENT CONTRACTS (MECs).
It is a powerful solution to a myriad of challenges our prospects and clients will be facing in the years ahead. Please take the time to learn how to use this vital tool.
We're passing on two of the newsletter's monthly sales ideas - every issue of the newsletter contains 7 ideas, plus one idea for the Canadian market. Subscribe to get them all.
Idea #2: Retirees Healthcare Costs Increase Again
Fidelity Investments and the Center for Retirement Research at Boston College just released their annual research declaring that health care costs had risen another $5,000 above last year's research to $285,000 and $125,000 higher than they were in 2002. If you extrapolate that information by 2036 it could be between $400,000 and $500,000 just to pay healthcare costs in retirement.
With 73 percent of Americans making less than $50,000 per year of income that means 40 to 50 percent of retiree's annual income will go to healthcare costs. Astonishing! An important part of our planning duties will be to help retirees plan for these enormous healthcare costs. Let me remind you again: There are 140 million Baby Boomers and Generation Xers turning 65 in the next 25 years. Where will they get the money for these healthcare benefits?
Title: Date Points: Retirees facing higher healthcare costs
www.modernhealthcare.com (Modern Healthcare, April 20, 2019)
Idea #6: Parents and Grandparents Open the Family Bank
75 percent of young adults between the ages of 18 - 34 are not able to afford their lifestyle without ongoing parental support. Parents spend over $500 billion per year on their adult children. That number is equivalent to the amounts people contribute to their retirement accounts.
Grandparents spend more than $179 billion annually on their grandchildren. That is close to $2,600 per year. AARP says the impact grandparents have on their grandchildren's lives is immense. This sale is easy!
Ask parents and grandparents what happens to their family members if they are not there to provide the financial support they are currently giving? Shouldn't that support be available whether you are here or not? Remember I talked in the beginning about single premium life insurance? What if the grandparents could use most of the money while they are alive and have it replenished income tax free when they die? At the very least wouldn't they want to know about it?
Please read these articles. Use them with parents and grandparents to inspire some planning and strategizing. You will be considered a “Godsend” to these families.
Title: Grown children may be hazardous to your wealth
www.investmentnews.com (Investment News, April 18, 2019)
Title: Grandparents are spending approximately $179 billion on their grandkids
www.fa-mag.com/ (Financial Advisor, April 9, 2019)
Get more sales tips and insights when you subscribe to Van Mueller's monthly newsletter.
This was just a taste of what he publishes each and every month. If you want to read more, click here to become a subscriber.