Invest savings in variable life policy?

Feb. 1, 2003
Recently, several life insurance agents recommended that I use all of my savings to fund a variable life insurance policy.

Charles Blair, DDS and John McGill, MBA, CPA, JD

Recently, several life insurance agents recommended that I use all of my savings to fund a variable life insurance policy. While this investment would require the use of after-tax dollars, it would provide the tax deferral associated with retirement plans, but with no staff-funding costs. What do you think of this idea?

Run, do not walk, from these agents who are trying to steer you in the wrong direction! Recent tax-law changes have resulted in one or more types of qualified retirement plans that are cost-effective for virtually every doctor's practice. For example, under a SIMPLE-IRA plan, doctors (and employed spouses) can each defer up to $9,000 from their pay on a tax-deductible basis, while the practice makes a 3 percent of pay matching contribution. Contributions on behalf of the staff are required only to the extent that staff members participate and contribute to the plan from their own funds. Matching staff contributions are limited to no more than 3 percent of pay.

As a result, most doctors' families end up receiving 90 percent or more of the benefits available under a SIMPLE-IRA plan, and there are no annual legal or administrative costs associated with the plan. Other types of retirement plans may work equally well for doctors wishing to make larger tax-deductible contributions.

Furthermore, while variable life insurance policies do provide a tax-deferral benefit similar to that enjoyed by retirement plan and IRA accounts, it comes at a relatively high price. As a general rule, significant sales, administrative, and insurance costs eat up much of the tax-deferral benefit inside a variable life policy.

Finally, the variable life policies are an even poorer investment vehicle, given the most recent tax-law changes. Under the new tax law, doctors holding stock investments personally pay a maximum tax rate of only 15 percent on dividends and long-term capital gains. Thus, the taxes deferred by using a variable life insurance policy are substantially lower than in prior years. For more about tax-saving strategies under the new law, send a self-addressed, stamped ($0.60) envelope to Blair/McGill & Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, and request "How to Reap Maximum Tax Savings from the New Tax Law."

Many years ago, I purchased a $750,000 whole life insurance policy on my wife. Since I assume she will be the second to die, the proceeds of the policy are to fund potential death taxes. Currently, the premiums of $25,763 a year are paid by our daughter and her two children out of annual gifts made from us to them. This policy has been in existence for five years. The insurance company claims that premiums will cease in about 14 years, and that all future premiums will be paid from policy dividends. The insurer is suggesting that I assign all future dividends to pay the premiums in order to lower my current out-of-pocket costs. Is this a wise choice?

Since the estate-tax exemption will be increasing in the future, and the stock market has reduced our net worth to only $3,000,000, would it be better to cancel the policy? I hate to do this, since I have already spent almost $129,000 in premiums, and the cash value is only $80,000 now.

The estate-tax exemption increases from $1,000,000 to $1,500,000 per spouse in 2004, and to even higher limits in future years. Beginning in 2004, your family would owe no death taxes if your estate-planning has been properly structured, since each spouse could utilize his or her $1,500,000 exemption to completely eliminate the death taxes on your $3,000,000 estate .Accordingly, the purpose for which you bought the policy may be rendered moot.

We would definitely recommend using existing cash value and dividends to pay current premiums on the policy, in order to reduce or eliminate your current out-of-pocket premium costs. Determining whether to cancel the policy is the next economic question. To make this decision, you must determine whether the present value of the future life-insurance proceeds ($750,000) exceeds the present value of expected future premium payments, given your wife's life expectancy. If the present value of the proceeds exceeds your expected future premium costs — based upon your wife's life expectancy — the policy should be kept. If not, it should be cancelled.

Dr. Blair is a nationally known practice-profitability consultant, and is a member of the American Academy of Dental Practice Administration. Mr. McGill is a tax attorney, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($195 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, or call (704) 424-9780.

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