Would You Like To Earn a Higher Interest Rate While Still Having Liquidity?
Thursday, June 29, 2017
Earlier this month, I asked a client if he wold like to earn a higher interest rate while still having liquidity after he complained about the paltry earnings on his corporate cash management account. He needed liquidity for his $500,000, but the interest on his savings account wouldn’t even pay the light bill. So, we had a chat about another approach.
How about you? Do you have money sitting in a bank account or a CD earning a measly ½ – 1% interest? Do you want to earn a higher interest rate while still having liquidity – the ability to get at the funds for an emergency or opportunity?
Have you heard of using a special hybrid form of insurance as a liquid source of funds, and at the same time, earning more than a savings account or CD? My client hadn’t heard of this idea, and chances are you haven’t either. Read on to learn more about this unique way to earn a 2 – 5 times higher return, while still having a liquid source of funds …
Tax Benefits While You Earn a Higher Interest Rate and Still Have Liquidity:
The new hybrid insurance contracts have the following primary tax benefits:
- Tax-free borrowing
- Money grows without tax. No annual capital gains or dividend taxes to worry about on earnings
- The survivor benefit is income and capital gains tax-free to your heirs. (And, can be free of Federal estate taxes, too, if properly designed)
- Distributions are not included in the “provisional income test” – which is used to determine the amount of Social Security income that is taxable
- There is no required minimum distribution rule for the values accumulating inside these hybrid contracts as there are for IRAs and other pre-tax accumulation plans
- Greater cost basis. If a contract is surrendered, the cost basis is determined by the entire premiums paid – not just the portion of premiums going to “the investment” side of the contract
- Long-term care/chronic care/accelerated death benefits in the event of certain health conditions occurring are not taxable even though received while the insured is still alive
What is the “Engine Under the Hood?”
Most often, we use an “indexed” type of life insurance contract for this cash management concept. An indexed type of contract uses different indexes linked to various stock markets. For example, the index could be the Standard & Poor’s 500 Index or some similar type of broad market index.
Since this is classified as a life insurance contract, there is a cash component as well as a pure term insurance component. The cash component is in recognition that someday there will be a death, and that a “reserve” must be established. Since in our “cash management strategy” we don’t care if there is a survivor benefit at all, we squeeze the coverage down to the very lowest allowed by the IRS. Often, the face amount is fractional to the amount normally generated if a survivor benefit was the objective. Therefore, the bulk of the contributions go into the cash component bucket, which grows by the performance of the various indexes selected.
Over time, you will have access to roughly 92% of the cash building in this reserve. This money can be used for an emergency, opportunity, education funding, and most often, supplemental, tax-free retirement income.
“Idle Money” Strategy
By using one of these “hybrid” contracts, we get the following:
- Liquidity — you have up-front access to the cash values growing over time, even in the early years of the contract … upwards of 95-100% of the premium in year 1
- Much greater rate of return over time than a CD or savings account
- The power of 0% — the rate of return for your chosen indexes will never be a negative number … principal is always protected even when the financial markets tank
- Chronic illness and long-term care riders to protect your assets from a catastrophic long- term care event
- Protection from living too long and the danger of running out of income
The best use of this tool may be for a person in their 50s or 60s who does not have estate tax issues (i.e. assets less than $5.49 million if single or $10.98 million if married.) Some of our largest transactions have been with clients who didn’t want or need insurance … but wanted/needed what these contracts can do!
In as few as 5 years of contributions/premiums into the contract, you will typically earn a rate of return that will be at least 2-5% more than if your money was placed in a CD or a savings account. The longer it accumulates, the greater the return.
Adding yet another benefit, there is a chronic illness rider which states that if you cannot meet two of the six activities of daily living, then you receive 4% of the survivor benefits each year … tax-free! (The six “activities of daily living” are: bathing, dressing, transferring from a bed to a chair or wheelchair, toileting, continence, and eating.) Even better, if you do not have a chronic care occurrence, there is no cost for this provision. You only pay if you use it!
Perhaps the greatest feature of these contracts is in response to the uncertainties and volatility of today’s markets and economies. These contracts typically use indexes – which can and do have negative returns quite often. (Every 3.9 years on average.) These contracts, however, have a “floor return” regardless of whether the index “goes south.” We refer to this as “the power of 0%” … that is, even if the S & P has a return of -38% again as it did in 2008, you receive a 0% return. This means that you will never again have a loss in principal due to a negative return in the index.
Just as there is the 0% floor return on the index, there is often a cap on the upper end as well. The ceiling changes modestly as the markets go up and down, but the cap is usually within 85% of the highest average returns … which for most folks is more than adequate. And, the latest wrinkle is that you can obtain a specialized contract without a cap—the cost is slightly more for this type of contact but there is no upper ceiling for the indexes return! If the indexes rise by 40%, then 40% is credited to the contract’s return.
An additional application of this concept concerns those in the construction trades. Often, a contractor is required to keep liquidity for their performance bond. This “idle money” strategy could be used as a substitute for keeping the necessary cash reserve. It is an asset in lieu of pure cash, and is preferred by the bonding companies. It is still liquid, but provides many other benefits – including a replacement source of dollars for the key person now missing from the business because of a premature death.
If you would like to see how the “idle money” concept could work for you, please call or email. Let us run some numbers for your specific situation.
A life insurance contract used just for its “living benefits” … Imagine That™!