Single Premium and Prepaid Premium Life Insurance – Episode 189

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[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler and No BS Money Guy, Todd Strobel. Hey everybody, welcome back to the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. Once again, we have bestselling financial author, Kim Butler with us today. And we’re going to be talking about, well, it’s kind of a product of the past and matter of fact that it was very successful at one time, and that’s single premium life. And if anybody wants to know the secret of where Susie Orman made the majority of her money, it was selling single premium life insurance.

[00:54] Kim, I’ll kind of let you explain the law changes and why the product just had to kind of go away. Well, the modified endowment contract ruling, which I think was either 86 or 88, just absolutely obliterated the product’s effectiveness. Now, that didn’t make the product go away. There are definitely still people that do single premium whole life insurance policies. And essentially what those are called are modified endowment contracts because the modified endowment contract test, which is both a single year and a seven year cumulative test, it essentially eliminates the ability to put a lump sum into a life insurance policy and still get life insurance tax law. So you can absolutely put a lump sum into a life insurance policy, but you cannot get

[01:55] life insurance tax law. So let’s get some definitions clear. Life insurance, of course, is after-tax dollars that then grows tax-deferred. The technical most accurate term is tax-deferred and can come out tax-free depending on what you’re doing with it. And again, I want to circle back to the tax-deferred word because a lot of people say, well, why can’t you say that it grows tax-free? And you could if you absolutely, positively knew for sure that the life insurance policy was going to stay in place. But because people’s lives change and sometimes they cancel those policies, if cancellation occurs, cancellation of the policy before death and there is a gain, meaning it’s worth more than you’ve put in, that will be taxable.

[02:48] So the proper terminology is truly tax-deferred. I would like to point out, though, that the entire amount of money is not taxable, just the gain, correct? That is correct. Yeah, that’s an important distinction as well. And it’s interesting when the modified endowment contract limits and that law came into being, there was a lot of thinking around and article writing around this product, this essentially new product called the modified endowment contract and how negative it was, et cetera, et cetera. And I don’t agree with that. I think over time it has lessened. There are absolutely cases where a modified endowment contract would be viable. And essentially, the tax law around that is you still have an after-tax premium

[03:38] payment, an after-tax pay to petition, and then you have the tax-deferred growth. Nothing has changed there, but anything coming out, no matter what you do to it, whether it’s a loan or a dividend or anything, is going to be taxable. It essentially makes it more like an annuity. So it also means you have the 59.5 age limit, whereby if dollars are taken out, then I think there’s still 10% of penalty that apply on top of the taxes. Is that right? Do you know off the top of your head? I believe so. And the death, more importantly, I think, is the death benefit becomes taxable. Yeah. So you definitely have not the most efficient environment in this modified endowment contract. So fast forward to today, people still, our listeners still, for whatever reason,

[04:37] seem to want to put in a single premium or a dump in or a lump sum whatever term you want to use. And so I recently just did a whole other round of research just to make sure I wasn’t missing anything, contacted three or four of our main carriers and asked for illustrations for single premium policies. And in every case, essentially what I got was a two-pay policy, in other words, pay a premium in the first year and the second year, plus a prepaid premium account. Now, there’s nothing wrong with this strategy, but I find that when I share it with clients, they don’t really want to do it. So I want to elaborate on the strategy a little bit more. So what typically is going on in the year 2017 here when we’re recording this,

[05:32] if you’re being talked to about a single premium policy, and there may be one out there that I’m missing, but from everything that I’ve seen, it’s a two-pay policy. So you backdate your policy six months, you pay one premium now, that’s for the quote first year, and then you pay a second premium in six months that’s quote for the second year. And then you’re going to put a good three to maybe even five additional premium payments and pay to petition contributions into what’s known as a prepaid premium account. And this is essentially just a savings account at the insurance company. I do find that they pay pretty good interest. It’s usually three, three and a half percent. Some insurance companies literally pay the interest.

[06:22] Others discount those third, fourth, fifth, sixth, seventh year premiums by, again, about the same three, three and a half percent. Either way, it works, but it is taxable and it’s also not liquid. And you cannot borrow against it. So it’s not really cash value of life insurance at all. It’s truly exactly what it sounds like it is, which is a prepaid premium account. And it works, but I find most people don’t like it for some reason. So, questions. I think the biggest objection that people get is the interest is payable each and every year. So it’s not when something happens inside the insurance policy. They literally get a 1099 similar to a 1099 interest statement each and every year. And they were attracted to life insurance because of the tax rules.

[07:22] And when the insurance company is acting basically as a I guess, as a lender instead of a insurance company, then they are no longer operating under those same tax laws. Right. And in this case, yeah, you could even call them a bank because it truly is as much like a savings account as anything I’ve ever seen. It’s interesting. I think the desire for this from our listeners is to have a place where they can know that they’ve paid for their insurance policy and it’s over and done with, which is interesting to me because we don’t do that with our car insurance. We don’t do it with our home insurance. We don’t really do it with our mortgages. There’s lots and lots of things in our life, you know, our cell phone bill that we just pretty much know

[08:13] we’re going to pay for every month or every year. A car is the same category. And yet, for some reason, people get kind of caught up into either, I think, fear and uncertainty around their life insurance premium payment schedule and, oh, my gosh, I don’t want to be obligated into this every month, every year. I understand that. And there’s lots of ways to solve that problem. I’ve written about it extensively in our little live your life insurance book, which is available on Amazon. You can grab it as an audio version. And I’ve shared numerous examples of what to do if you can’t pay the premium. We’ve got some blog posts on it as well about all kinds of different things that you can do if you can’t pay your life insurance premium.

[08:55] Our family went through a period from 08 to probably, I don’t remember, 2012 or 13, where we couldn’t pay our life insurance premium. So once you get a policy started, the easiest thing to do is called an automatic premium loan. And you just borrow against the existing cash value to pay those premiums. It’s why it’s so important to have your emergency slash opportunity money stored in the life insurance company so that you can use it for things like premium payments when you don’t have the cash flow. You could even put it into pay to petitions if you wanted to. I think generally speaking, if people are in hunker down mode, they’re better just paying the premiums and not trying to do pay to petitions.

[09:43] But it’s something that is available to you, this cash value and the automatic premium loan to handle however you like. But let’s remember the value of continuing to pay premiums. It’s just savings. It’s forcing your family to save. And there’s so much good in that that I’m really going to caution people to stay away from the short pays and the single pays and the 10 pays and the seven pays, et cetera. And just by the policy, intend to pay it as long as you possibly can and really enable those dollars to just continue to build and to be there for you and your family’s future. I think it’s important to get a true financial professional like a prosperity economics advisor versus a typical life insurance agent

[10:36] because you will hear life insurance agents automatically avoid MEX or modified endowment contracts. And there is a time and a place for those products, isn’t there? Absolutely. It’s something that people just need some individual guidance on, which we’re, of course, happy to provide. If you have questions about this, you’re welcome to reach out to us. Hello at partners, the number four, prosperity.com. And we’d be happy to help if you have an illustration and it says this policy becomes a modified endowment contract, say in year 42, you just need to stop paying premiums in year 41 and you can solve that problem. But if you’re unsure, then reach out to us. We’re happy to help. And Kim, correct me if I’m wrong, but a lot of people really get concerned

[11:26] that all of a sudden overnight, their policy is going to accidentally, there’s going to be a higher interest rate or a higher dividend paid and they’re going to end up with this modified endowment contract. And the life insurance companies, at least in my experience, work really hard and even will offer to send the premium back to make sure that that doesn’t happen. So it’s really something that they take care of. You don’t have to sit up nights worrying about it. Absolutely. The insurance company keeps an eye on it. They often also alert us. I’m not going to say we’re perfect at catching it, but they are and they usually give you a good 30 to 60 days to get it rectified. So it’s easy to fix if you get a letter that says

[12:09] you’ve turned your policy into a modified endowment contract, just find out how much cash needs to be removed so that you get back down underneath that modified endowment contract limit and then go forward again. It’s not something that is going to change quickly without you knowing it. However, once it does change, so let’s say you don’t do anything and the 30 days passes, then it is very difficult to adjust it. And we have lots of clients that do have modified endowment contracts on the books either because they wanted it that way or it got that way accidentally. It’s not the end of the world. The cash is still there. The death benefit is still there. There will still be good available for that policy,

[12:55] but it really depends on your family situation and whether or not you want it to be that way. And I’ll just give you an example. I used to be heavily involved in college planning and if you have $100,000 sitting in CDs or you have $100,000 sitting in a stock or brokerage account, now we’re not talking about tax deferred money. We’re not talking about retirement money. We’re talking about after-tax money and you apply for financial aid. Those assets are actually penalized against the amount of financial aid that you qualify for. So sometimes, not in every situation, it would make sense for somebody to move $100,000 into an endowment contract. The endowment contracts, I must admit, used to be a lot more attractive

[13:50] and paid a lot better than what they do now. But in some cases, it allows people that would ordinarily not get financial aid to get financial aid. And with the average cost of college being over $30,000, that could make a significant difference. Absolutely. Yep. Very valuable tool. And life insurance is definitely the asset of choice in our minds to save money for college, but often it’s life insurance on the adult, not on the child. Many people look at life insurance on the child as the spot to save for college. And you just can’t really get that much money in there unless you start fairly young and with quite large policies, which is an option. There’s lots of families that do have that capacity.

[14:37] And we love life insurance on children. You just have to be conscious of the dollars in and the age of the child. And then, of course, also checking out the modified endowment contract limit on that as well. We have thrown out a lot of jargon, terminology, whatever you want to say. I think this would be a good time for you to mention the book that you wrote about life insurance because it’ll go step by step and give you all of these definitions and what they mean and how they work. Absolutely. So that Live Your Life Insurance books, a nice short read again on Amazon and available for both paperback and audio. And I’m thinking an immediate download. Well, no, Kindle. We’ve switched everything to Kindle these days.

[15:25] So there you go. Super. Well, we appreciate our listeners. We appreciate your time. We realize that this conversation may have sparked some questions, realize that everybody’s situation is different. You should never make financial decisions off of what you hear somebody talking about on a podcast. You need personal guidance from a prosperity economics advisor. We’d be glad to help you find one. We appreciate you. And Kim, I appreciate all your information today. This is the No BS Money Guy for the Prosperity Podcast. Take care, everybody. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com. If you liked this episode,

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