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| Risk & Reward |
A Hybrid Haven
Eileen Gunn
10/01/2004
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It is possible to extract some
capital from the policy while keeping the life insurance active and the
investment growing tax-free. The IRS allows us to withdraw the amount we
originally paid for the policy without penalty or tax. Beyond that, we can
borrow against the policy. If we choose not to repay the loan, at death it will
count against the benefit. But, we have to leave some money in the policy to
ensure it grows quickly enough to outpace the ongoing costs, including any
interest on the loan.
The Wall Street executive whom Book advises plans to
do just that. He will leave the assets to grow for eight to 10 years. “Then
he’ll probably take out the amount he initially put in, and then a little more
beyond that,” Book predicts. “We’ll invest the money we take out in something
else. And we hope what we leave in will grow to cover his estate
taxes.”
Indeed, the death benefit is perhaps the most overlooked aspect of a
private-placement policy. Clients tend to think it is irrelevant, advisors say,
because they expect their investments to grow strongly, ideally beyond whatever
the initial death benefit might be. Unfortunately, the IRS mandates that
insurance companies must bear at least some risk in the insurance policies they
sell. This means the death benefit always has to be larger than the policy’s
cash value by a minimum ratio that depends on our age and other factors. The
insurer charges us a “cost of insurance” fee—generally less than 1 percent of
the cash value—to bear that risk. That cost prompts many advisors, such as John
Dadakis, an attorney in the New York office of the law firm Morrison and
Foerster and a private placement specialist, to advise their clients to buy the
smallest death benefit allowable.
For those of us who are willing and able to
abide by the restrictions, complexities and costs of private-placement insurance
in exchange for long-term, tax-sheltered growth, these policies can be ideal
low-risk investments. “You don’t need to go into high-risk, high-return
investments that are up 30 percent one year and down the next,” Book says.
Because they provide tax- sheltered, compounded growth, “You can earn a steady
10 percent and make a killing.”
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