APTs are Not a Substitute for Insurance

Today, I’m going to take on a question that I’m asked alot from doctors. Mostly from people who are sick and tired of paying outrageous insurance premiums to protect themselves from the inevitable lawsuits we have in the United States. Well, the question is Rob, if you do great asset protection for me, can I just get rid of my insurance?

I’m sick of paying $100,000 a year of insurance company for a policy that I’m not even sure is going to protect me if I’m sued. So, make me poor, protect everything. Well, guys it doesn’t work that way. What I’m here to tell you is that asset protection planning is very important. It’s as important as any of your business planning but it is not an alternative or a substitute for insurance.

Insurance is a good line of defense in a solid asset protection plan

Insurance is good because it provides you a defense. That’s what I like about insurance. Insurance provides you with a defense and that’s oftentimes the worst part about being sued. It’s a horrible process. There’s no such thing as a good lawsuit as you’ll soon learn. But it’s even worse if you don’t have somebody paying your legal fees. So, take this home with you. Rule number seven:

Asset protection planning is not a substitute for insurance. Get your insurance. Get high deductibles if you want and don’t count on your insurance to always protect you. Insurance companies are great at putting loopholes and ways for them to get out of honoring the handshake contract you at least think you have and they’re getting worse as money gets tighter. But don’t look at asset protection as something you can do and then forget about insurance. It doesn’t work that way.

I once had all the baby doctors, all the obstetricians and gynecologists in one city up in Oregon fly me in. I protected all seven of them. It wasn’t that big of a city. We all got together. Each one of them is well-protected.

Each one of them is essentially judgment proof. Each one of them still maintains errors and omissions insurance because each of them is going to get sued because as you know, at least as they know, if you’re delivering babies you become almost equivalent of a guarantor of a perfect birth. It’s the same in many other fields. So, get your insurance because it provides you a defense.

How To Live a Tax Free Retirement and Have Income for Life Guide

by James Burns

One hundred years ago only one in four Americans lived past the age of sixty-five. Today, three in four people surpass sixty-five. We expect to live longer and with the tremendous advances in medical science people living into their eighties and nineties is going to become commonplace.

Emerging generations are going to need a more effective financial strategy due to this increase in life expectancy, not to mention the fact that costs are rising while the value of the dollar is shrinking worldwide.
The two previous generations, the immigrants and the baby boomers, had a different way of looking at life. They were taught four principals that were supposed to create success and happiness if followed correctly:

1. You get a college education

2. You get a job,

3. Get married and start a family,

4. Buy a house and pay it off as soon as you can, so you can be secure in your retirement.

The evidence is now clear that this formula no longer works in creating the kind of wealth the current generation of workers will need in retirement. The US Department of Health and Human Services says that 36% percent of sixty-five year olds are still working, 54% are dependent (require family or government assistance), five percent are deceased, 4% are financially dependent (with at least $3,000 per month to live on) and one percent are wealthy.

We know because of our aging population that providing Social Security to future retirees will require higher taxes or reduced benefits. And, as we‟ve discussed throughout this book, the traditional retirement formula is going to leave you broke. The wide use of mutual funds tied to market volatility that contain both disclosed and concealed fees is just not reliable.

If you consider John Bogle‟s insightful examination of three hundred fifty-five funds over a thirty-five-year period,1 there is no question that most mutual funds are not where you want your retirement dollars. Even if you find a good index fund, it may be so overly saturated that getting ahead will require some form of miracle.

The ideal long term savings vehicles have a few common characteristics:

1. Performs Well in a less robust market

2. Reduces or eliminates risk

3. Tax Efficient

4. Low Expenses

The future of our tax scheme is uncertain but the Washington Post provided the following comparison of the two presidential candidates. 2(article)

retirement chart

At the time of this writing you can see it is prudent to consider total tax-free income in your retirement years. I make no proposal for either candidate but the messages are clear based on the comparison that Senator Obama will increase taxes across the board. Senator McCain will likely have to do more and most tax prognosticators agree that the entire marginal tax rate has to shift upward to meet the demand in debt, benefits to Boomers and the war on terror including the Homeland Security aspect of it.

The American Dream of being able to ascend your class is being foreclosed on and the recipe for even more difficult times are ahead if we have the one plan that threatens the break-out upper middle class and makes them pay everything. You‟ll absolutely need to have a tax-free (4) income strategy in your retirement years. Even if this never came to pass the idea of deferral just does not do justices because most Americans retire in a higher tax bracket if they‟ve been successful and if the entire table shifts, anything you have in a deferred plan will be taxed at the then ordinary income which means, you‟re deferral will be lost within 2 years typically. Just ask yourself this question, does it make more sense to be taxed on the seed or the harvest?‟ If you said the harvest you‟re right. Think about it, a seed is much smaller and that would be the time to be taxes and a harvest is of plenty which means much more tax eating away at it.

The Two Hidden Tools for Tax Free Income

Tool#1 – Solo K Roth (Rating 1, 3, 4)

There is also a Solo Roth 401(k) which is a 401(k) for an individual that beats the Roth IRA five times over. Unlike the previous opportunity for retirement savings (the Roth IRA), the new Solo Roth 401(k) will allow an individual or married couple who own their own business, to sock away up to $98,000 per year for retirement. Of this amount, $40,000 can be composed of after-tax Roth elective contributions (provided the individual, and their spouse, if applicable) are both over fifty. So now, for the first time in history, a retirement saver can put up to $20,000 in a retirement plan that can grow annually into a retirement plan that can grow tax-free for their lifetime.

Not only is this amount five times greater than what can still be put into a Roth IRA ($4,000 limit, plus a $500 catch up if older than 50), but there is no cap on the amount of income an individual can earn before he or she becomes ineligible to contribute. So, while one is (5) restricted from contributing to a Roth IRA when he or she earns more than $110,000 ($160,000, if married filing jointly), no such restriction exists for the elective Solo Roth contributions!

In addition, with the Solo Roth 401(k), you can invest in two types of investments (“S” corporation stock and life insurance) that are restricted for Roth or traditional IRAs. Moreover, unlike your IRA where you cannot take out a loan, you can personally borrow up to $50,000 or 50% (whichever ever is less) from your Solo Roth 401(k).3 That provides a cash flow opportunity that a Roth IRA cannot provide.

Here‟s an example of how it works: say you earn $100,000 in 2007 from your sole proprietorship. Your maximum solo 401(k) contribution would be $35,500 (that is, the $15,500 maximum salary deferral contribution plus 20% of the $100,000 you earned). With traditional self-employed retirement plans, your maximum contribution in this case would be $20,000 dollars instead, which is much less.4

In addition, the contribution limits for a Solo Roth 401(k) are much higher than the $4,000 Roth IRA contribution limit. So if you‟re self-employed or a business owner with no employees other than your spouse, a solo Roth 401(k) is a great way to sock away more money into a Roth and reap the benefit of tax-free growth on your earnings.5

5. Id at http://www.penscotrust.com/education/solo_roth_401k_and_solo_401k.asp
6. Money Girl – http://moneygirl.quickanddirtytips.com/solo-401k.aspx

With traditional IRAs and Roth IRAs any income or capital gains on debt-financed property is taxed at the trust tax rate (generally 35%) to the extent that debt supports the generation of the income. This is a very important benefit to real estate investors who are in the position to be eligible to form a Solo 401(k). Unlike investing outside of a retirement plan, where taxes apply to net income and any gains generated by debt financing, unless they are sheltered through a 1031 exchange, 401(k) plans are exempt.

The secondary benefit is the avoidance of having to go through the 1031 process and its expense. So, for example, you could literally buy a house in the morning with $100 down and flip the purchase contract in the afternoon, without paying any tax on the gains. The gains would
be tax-deferred thereafter, if they had been funded by the tax-deferred components of the Solo 401(k), or tax-free if funded by the elective Roth component.

In conclusion we have the opportunity to perform well in a less robust market because you can fund your solo-401(k) or self-directed Roth IRA with real estate and other assets that are not connected to the market. You cannot reduce or limit risk with this vehicle because there are no safety measures built in like the insurance chassis. It is definitely tax efficient because you‟ll pay no taxes in retirement by having a ROTH where you’ve paid your tax up front on the seed rather than the harvest. Finally, the expenses can be reduced by creating and LLC that does most of your investing but you are also disconnected from the usual market fees by using real estate and debt related investment assets to fund this plan.

Tool #2 – Savings Grade Life Insurance

The Two Major Applications of Life Insurance

There are two main uses for life insurance from a goal setting perspective. The first is succession capital, which is what people generally hear about in regards to how it will protect their families or estate in case the breadwinner departs. It‟s the money your family or estate receives in the case of your death. However, you also have lifestyle capital, which is designed to create future tax-free cash flows as a supplemental retirement income. Unlike your pension plan, which will be taxed as ordinary income at your tax bracket; this income can be distributed tax-

If you are not thinking about your net “spendable” income (NSI) in your retirement years,then you‟re not developing a winning wealth plan. You need to know exactly how much you‟ll need to maintain your lifestyle when you retire. You‟ll also need to factor in the costs of increasing medical needs.

Succession Capital

Using other people’s money (OPM) with the intent of realizing a financial gain is a financial concept that has been practiced by real estate developers, investors, business owners and entrepreneurs for centuries. Today, this concept is being utilized to purchase life insurance, and has raised the eyebrows of insurance promoters and financial professionals alike. But, does this concept offer economic substance or is it just another sales tool to sell life insurance?6

Life insurance is an important part of any high net worth individual‟s financial picture. Since adequate life insurance usually requires significant premium payments, the premium financing strategy can be an effective solution for clients who do not want to liquidate assets to fund their life insurance premiums.

Premium financing is a method of funding the purchase of life insurance for those individuals who have significant assets, but do not have or want to use liquid capital to pay the premium on a life insurance policy. By borrowing the money to pay the life insurance premiums with a loan, the insured individual frees up capital that can be used more efficiently. The use of premium financing may lower out-of-pocket costs and potential gift taxes.

Qualified vs. Non-qualified Plans

I‟m often asked the difference between qualified and non-qualified plans and I think it is important to explain it by example since most tax preparers look at the pretax dollar aspect of a qualified plan. My mantra is “it is better to be taxed on the seed rather than the harvest” which runs contrary to the conventional tax preparer way of thinking.

6. Andre Blaze, “Life Insurance Premium Financing—What to Look For.”


Joe, age thirty-five, wishes to retire at age sixty-five; Joe is in the 30% tax bracket
Joe deposits $30,000 per year for thirty years at 8% interest, equaling $3,398,496.
Joe receives a tax savings per year of $9,000, for a total tax savings of $270,000.
Joe would receive a “net” retirement income of $290,000 per year, assuming a 30% tax bracket.
His money would last for just 13 years.
Total taxes paid by Joe on his retirement income would be over $1,500,000.
Total net retirement income after taxes of $3,900,000.

John, same age deposits $30,000 per year to the age of sixty-five, assuming an 8% return.

John receives NO tax savings on his deposits.
John receives a “net” retirement income of $290,500 per year to the age of one hundred plus.
John‟s total taxes paid on retirement income equal $0.
His total net retirement income after taxes is more than $10,000,000.


Taxes saved on deposits are $270,000 on qualified plan. “0” on non-qualified plan.
Taxes paid on retirement income of over $1,500,000 on qualified plan and
$0 paid on non-qualified plan. That equals a tax savings of over $1,230,000.

Total net income paid of $3,900,000 on qualified plan, and $10,000,000 paid on non-qualified plan. That‟s a difference of $6,100,000.
Overall difference of $7,330,000.

The non-qualified plan has an initial death benefit of over $2,000,000 in case John was
to pass early. You‟ll have to be the judge, but the smart approach to the money would be looking
at the end game. It truly is better to be taxed on the seed than the harvest. Perhaps the best
solution is to use both and spend down the least efficient dollars first; these are the qualified plan
dollars subject to ordinary income tax. Then use the non-taxable funds that are created with a
non-qualified strategy.

Lifestyle Capital

Many investors are unaware that cash value life insurance is the only investment tool that acts as a self-completing college funding, a supplemental retirement savings plan and can be creditor proof in some states. A great argument these days is that the cash value build up is the functional equivalent of a retirement plan garnering comparable protection. Fabulous feature include the ability to build-up and not count this cash value as an asset for the purpose of financial aid when your children head off to college.

Finally, by over funding a cash value life insurance policy, up to the modified endowment contract (MEC)7 guidelines, it can become “savings grade life insurance.” To further maximize the opportunity with life insurance in order to take advantage of the tax-free environment you overfund in relation to the death benefit.

7. A modified endowment contract is defined as any life insurance contract entered into on or after June 21, 1988, that meets the life insurance requirements of Code §7702, but which fails to meet a special seven-pay test or is received in exchange for a modified endowment contract [I.R.C. §7702A(a)].

Over funding is a strategy that focuses on accumulating cash in the policy rather than paying for the death benefit which is the payout to your loved one’s when you pass away. This approach leverages the highest policy premium that is allowed with the lowest life insurance death benefit so that your cash accumulation exceeds your policy net insurance costs over at least 10 years. There are fundamentally 4 steps to determining the combination of maximum premiums and minimum death benefits necessary to selecting the most leveraged indexed universal life policy:

First, determine the person‟s maximum premium commitment over a…

1. minimum of ten years or more. The premium amount selected should be an amount that they can make regularly whether it is a monthly or annual payment and does not strap their cash flow. Universal life insurance policies offer flexible premium payments, but to get the maximum leverage you have to stay on course with a premium payment.

2. Secondly, determine the minimum insurance face amount and payment commitment along with your age and gender to make sure the numbers work based on your particulars. Most insurance illustrations provide the actual premium amount limits that meet the internal revenue code minimum requirements.

Next, go over the internal rate of return (IRR) of the policy to ensure you‟ll
3. be getting the full benefit of the tax-free accumulation versus what an ordinary investment would receive outside of this tax-free environment. Some agent‟s illustrate way too high like 8% which is unrealistic. We usually do ours at 5.25% and still kick the pants off other investments.

4. Finally, you must pay close attention to the maximum premiums allowable under the Internal Revenue Code which is referred to as the seven-pay premium limitation.8 As long as the total premiums for any seven-year period are equal to or less than the maximum allowable premiums for the seven-pay test,9 you‟ll be able to access the cash values in the policy at any time, tax-free and relatively liquid.

In essence, a life insurance contract that fails to meet the seven-pay test will be classified as a modified endowment contract (MEC). The seven-pay test is not met if the accumulated amount paid at any time during the first seven years is more than the total of the net level
premiums that would normally have been paid on or before such time if the contract provided for paid-up future benefits after payment of seven level annual premiums

8. IRC §7702A as part of the Technical and Miscellaneous Revenue Act of 1988 (TAMRA).

9. I.R.C.§7702A(b).

Accessing the savings

The reason you‟re able to access your savings in the cash value tax-free is because it will be characterized as a loan. This is a so-called “wash loan” because the interest rate the borrower pays and the interest rate the insurer pays on the cash value are the same, so each rate “washes out” or equalizes the other.

For example, suppose the current rate the insurer is paying on the cash value account is 7% and the policy loan rate is 6%. With a wash loan, the 7% rate would be reduced to 6% to match the loan rate. Fixed, indexed, and wash are the three loan options offered by many carriers these days. The goal is to use leverage to create more wealth with the right insurance framework and if it has a dynamic loan provision, you can make money on dollars that you’ve taken out taking advantage of arbitrage, which builds your cash flows. This can happen with certain insurance products that credit 140% of the S&P on borrowed cash values in the policy.

To illustrate, the loan interest rate is 5%, you get credited 140% of the S&P (up to a cap of 10%), which in this case creates 7% minus the 5% loan rate and you are left with a net result of 2% on money that is no longer in the policy. To understand this better, you should talk to a qualified professional planner.

10. If a loan is still outstanding when a policy is surrendered or allowed to lapse, the borrowed amount becomes taxable at that time to the extent the cash value exceeds the owner‟s basis in the contract. A policy loan is defined in subsection 148(9) as an amount advanced by an insurer to a policyholder in accordance with the terms and conditions of the life insurance policy. Although these advances are referred to as policy loans they are actually advance payments of a policyholder’s entitlement under the policy.

Final Words

As with any asset and financial blueprinting, you have to be careful of the tax implications, since taxes are the biggest expense you‟ll pay in your lifetime. If you want to have free control on the cash values in your policy then you‟ll have to run the risk of passing away before you get
a chance to spend it. While the death benefit transfers to your beneficiary free of income tax, the proceeds are included in your estate for the purposes of estate tax.

That‟s why many times an irrevocable life insurance trust (ILIT) or life insurance partnership (LIP) is created. The policies are either purchased by the entity or transferred to the entity if the policy preexists. When transferred it is considered a gift and requires some particularized planning in order to not exhaust a lifetime gift tax credit. The two vehicles we just discussed are so powerful that if you deploy them together you‟ll have a successful retirement in uncertain times. If you are married and a couple each quadruples the effects of the vehicles, in other words you both have both tools; you have a very bright retirement future.

Life Insurance 102

Life Insurance 102 – video transcript

Last time, we discussed the historical aspects of insurance when life insurance first came about, the various products and most importantly, the three fundamental questions you need to ask yourself about any life insurance purchase:

  • What do I need or do I need it?
  • How much of that life insurance do I need and what kind?

And we went over the various kinds of life insurance that are available or if you remember there was one particular product that I was talking about that’s now become the one that we used the most out there in the environment which is Equity Index Universal Life.

What you’re going to hear about today is that this particular insurance product can be an addition to retirement plan. It provides supplemental retirement income.

Now, what we aim to do with our retirement funds is create an income that will replace our income during the years that we worked in our retirement years when we’re not working.

We know that taxes are going to go up so if you didn’t know this, I’m going to reiterate it again, any 401(k) plan or IRA plan that you have will be taxed at ordinary income the day you start taking withdrawals out of it.

Now, the government also makes it mandatory for you to take those distributions when you become 70½ years old. Whether you need it or want it, you absolutely have to take it out and if you don’t, they’re going to penalize you at 50% plus the ordinary taxes that would be on that distribution and oftentimes we see that as much as 70% could be eaten away by the penalty and taxes on that because somebody just forgot to take a distribution that year because they really didn’t need the money.

You want to have some flexibility with another tool that you can take money out when you need it or leave it alone when you don’t need it and when you are taking it out. It’s going to be taking out tax free and (characterize this) alone.

So, when we look at where is the best place to save for retirement, we want to try and think about life insurance in a different context as a retirement planning tool. Now, there are only two reasons that stock prices go up over time and that’s rises in corporate earnings or increases in the profits and earning ratio.

This is something that was not adhered to during 2000 when we had a lot of the dot bombs or dot com companies that became bombs and blew up. People were just simply going off with a name of what they were supposed to be doing and instantly the buzz about that particular company will create such a rush, such a frenzy that everybody would be investing in that company was based on nothing, nothing traditional.

Here is the real basis for investing in company. It’s the rise in its corporate earnings and an increase in the P/E ratios. As we know going forward, these are absolutely the two things we want to look forward for doing any stock investment. And expansion of P/E ratios has accounted for 3.5% of the index as annual gain over the past 30 years.

So, if we look at the history of the S&P 500, P/E ratios have contributed to those gains significantly over the last 30 years. So, again, you want to pay particular attention to P/E ratios if you’re going to do any investing in a company.

I always recommend that people take a look at doing the index itself and you’ll see why in a moment.

We look at John Bogle. If you’re unfamiliar with who John Bogle is, John Bogle is the man that created that Vanguard 500 Index Fund. The man is a wizard of investing knowledge. In his book, The Little Book of Common Sense Investing, he stated my guess is that P/E might ease down to say 16 times reducing the market’s return by about one percentage point a year to an annual rate of return of 7%.

So, what that means is going forward, we only have about a 7% interest opportunity off of the stock market going forward in what looks like it’s going to be less robust market going forward.

Mutual fund performance: Studies have shown mutual funds underperformed the market and here is the study. One thousand two hundred and twenty-six actively managed funds with a five-year track record did 1.9% less than the S&P 500.

Six hundred and twenty-three actively managed funds with a 10-year track record did 1.7% less than the S&P 500. Four hundred and six actively managed funds with 15-year track records did 1.5% less than the S&P 500. Adjusted for survivorship bias, 1.5% worse with returns corrected for survivorship bias the average actively managed fund trails the market by about 3 percentage points per year.

Now, these funds are not even keeping on track with what the index is doing.

And here there was a great commentary from Motely Fool that said the truth of the matter is that over time the vast majority, approximately 80% of mutual funds underperformed the overall stock market. So, why would go anywhere else outside the index?

And here’s why the highest causes of that. It’s the actively managed funds have 2 to 3% management cost a year of different fees associated with it.

There is the sales charges, the 12b-1 fees, management fees, fund expenses, transactions costs and there’s a giant additional cost all of the more pernicious says John Bogle by being invisible.

I am referring to the hidden cost of portfolio turnover estimated at a full 1% a year. With that means is sometimes someone who is managing that fund leaves, resigns and someone else takes over and then there’s a turnover cost.

All these things put together you can see how they can eat away and they erode your funds that are sitting in there that are that are supposed to be building up for your retirement.

And as you sit back and contemplate upon that and think about how is this really affecting my retirement, you have to know based on the statistics that we just shown you it’s disastrous.

And why would you let a train that’s on the wrong track continue heading there when you now have this knowledge about putting it back on the right track.

Mutual funds are so profitable for everybody but the investor that there are now more mutual funds than there are stocks. Just look out there and see what’s available for investment. There’s more mutual funds in stocks and exchange and the reason is it’s a very profitable business.

My case in point is in 2008. Some of the people at some of the big wire houses are big. The financial institutions got Christmas bonuses in the $50 million range just for one individual.

Now, 2008 was a year when the market did absolutely nothing for anyone except for those folks with bonuses and you have to ask yourself where that money came from to pay those bonuses, oh these mutual fund fees right here of course. And what does this mean in dollars and cents? Well, if you had an initial investment of $10,000 over 50 years, we’ll just do a really extended period of time, 50 years, and assume that you got 8% annual market growth every one of those years, here is what it would look like.

Here is your market growth without expenses. That $10,000 would grow to $469,000.

But with just 2.5% annual expenses that’s reduced to $145,000. Almost 75% of it is eaten away because of those expenses and costs that are attributable to that investment.

And what does this mean again in dollars and cents? Let’s take a look at a long-term period of say 35 years, the typical period that you would be waiting to go into your retirement. Now, the same initial investment $10,000 and if you’re investing in the average equity fund out there, that $10,000 could grow to $98,200.

Now, if you just went and purely invest it into an index fund which has lower loads which means the costs and expenses are much lower, you could easily grow to $170,000. That’s almost doubling it by taking the expenses and the loads out of the equation. In fact, Peter Lynch himself said in Barron, the public would be better off with an index fund and indeed many of them have now created index funds since Vanguard first came out with the Equity Index 500 Fund. So, it’s very difficult to choose the right fund.

Let me give you a little story.

When I was going to my first law firm, I was going to participate in the 401(k) plan and instantly they handed me a little book and that book had a number of plans that would be associated with this plan and I didn’t know what any of these things meant. There was a bond fund. There was the international fund.

There was this fund and that fund and it was all very confusing and anyone that I wanted eventually sent me a portfolio or a prospectus that told me what it had done previously but they never told me what they thought it would be doing going forward.

And you get all these rankings and they tell you what they’ve done previously. It’s quite confusing. So, what I want to communicate to you is we’re going to take a look at what Forbes Honor Roll funds did. These are the crème of the crop, the best funds that Forbes found.

Okay. We take that same initial investment of $10,000. We look at it from a long-term standpoint of investing for our retirement and we’re going to take that period from 1974 to 1992 if we had taken those Honor Roll funds. And if we did that, that $10,000 will return to us $75,000 based on the Honor Roll funds.

If we had put those same funds into the average equity mutual fund which means we’re just going into funds that are outside of the Honor Roll, we’re going to have increased that up to $94,000.

Now, if we just invested purely in an index something like the Wilshire 5000 Index during that period. It would easily have been over $100,000 and so you can see the progression of being able to increase yourself or reducing expenses and going with sometimes simple investments.

Now, John Bogle says in his book, only three out of the 355 equity funds that started the race in 1970, less than 1% have survived and mounted a record of sustained excellence. And what does sustained excellence mean?

That means that it’s kept on track with the S&P 500 and that’d been cut short of what the S&P 500 did. So, I ask you again, when you went to work and you participated in your plan or you moved your money out of that 401(k) into an IRA and you started choosing funds, how did you choose the three at less than 1% that would actually do something compelling or something that would be excellent. It stays on track with the S&P 500. You’re probably not there.

Mutual funds provide no downside protection as well. When the market goes down, you take that ride all the way down with it. So, the S&P 500 by itself is over time has averaged a downside 17.6%. But wait, is that really that bad? Well, let’s look what some other funds did.

Well in 2001 the Merrill Lynch Mid-Cap growth did about 36.6% down. Merrill Lynch Focused Twenty fund was down 17%. So, as you can see, a lot of these funds end up being down even lower than the index when the market is down.

So, you’re compounding your losses. You’ve heard of compound interest, how about compounding losses. That’s sometimes what you’re going to experience by being in the wrong front. And finally, I want to look at what some experts have to say.

Buying funds based purely on past performance is one of the stupidest things an investor can do. That’s Jason Zweig from Money Magazine columnist.

And that’s exactly what they ask us to do everyday. Here is its prospectus. Here is what this particular fund has done previously but then there in the very small print they tell us future results are not indicative on past performance. So, basically they have just taken away everything that they’ve shown us.

There’s Ted Aronson, a partner with a money management firm. He says he’s owned a Vanguard Index 500 fund for 23 years. Once you throw in taxes, it just skewers the argument for active management. And he says personally I think indexing wins hands down.

After tax, active management just cannot win. And I’m going to hold back who said this next statement but let’s just read it together. It’s fun to play around. It’s human nature to try and select the right horse but for the average person.

I’m more of an indexer, the predictability is too high. For 5, 10, 15, 20 years you’ll be in the 85th percentile of performance. Why would you screw it up? And that comes from Charles Schwab himself. So, what he’s saying here is that you can screw it up folks if you don’t just stay with an index fund.

So, when we’re thinking about retirement, it’s long-term.

It should be at least a 10, 15 plus year ride and what is that long-term vehicle going to look like? Well, it should perform well in a less robust market. We just heard that the market is likely to return 7%, most likely less.

It should reduce or eliminate risk. Benjamin Graham who was the mentor for Warren Buffet used to say that an investment was something that protects your principle or preserved it and provided adequate return. Here we want to reduce and eliminate risk which is preservation of that principle. We should be tax efficient. We should have low expenses or expenses that decrease over time.

And that brings us to my conversation about life insurance, that Index Universal Life has some of these components. The cash growth can be linked to 140% of the S&P 500 with one product. There are several products out there. Not all of them credit 140%. Some are only at 100. They’re guaranteed not to go down if the market declines.

I’ll talk more about that in a moment.

There’s a low insurance costs and expenses over time which starts out a little higher initially but over time it decreases which is a few basis points.

It has tax free growth and tax free distributions and tax free distributions are primarily predicated on this idea that you have a dynamic loan provision and you’re going to be taking money back to yourself characterized as a loan and as you know a loan is not considered income in the eyes of the tax person.

Index Universal Life Dynamic Loan Provision: So, this is how this works. Traditional life insurance charges interest and then they credit you that same interest and that in the industry is referred to as no net cost or zero wash loan. So, in other words, you take up money and you’re charge interest. They now credit you that same amount of interest zero wash.

The way the equity index products work and we’re specifically talking about one of the products out there that we really like. Say we’re charging interest of 4.65%, while you’re getting credited 140% of the S&P 500 on this loan provision, it looks like this.

S&P 500 is up 5% while at that 140% marker, you’re almost being credited 7% of credit. Now, we subtract that 4.65% charge for the interest and you’ve actually netted a 2.35% profit on money you’ve not taken out of the policy. That’s called arbitrage. That’s where we’re getting a benefit by a variance in two different markets.

So, again, the cash money growth is linked to 140% or 100% with some products at the S&P 500 Index or we’ve just heard that you can’t go wrong by doing index investing.

It’s much more reliable than many of the funds that are out. You’re guaranteed not to go down if the market declines. Guaranteed, you’re going to keep all of your earnings. Low insurance costs and expenses, it descends over time and shrinks down to just a few basis points.

Typical management fees can be anywhere from 2% annually and as your funds grow that 2% is going to cost you a lot of money over time. Tax free growth and tax free distributions and a dynamic loan provision so that we take the money back to yourself for retirement. You’re going to be doing that tax free.

Annual Reset Feature: Now, what does mean? Well, here’s how it works. The best way is to articulate it here in an illustration. Say in year 1, if the market goes up 10%, you get credited some of that 10%. Well then in year 2, the market goes down 5%.

So, did I just lose 5%? Well, that would be the typical way that your investment would go if you were in a mutual fund and you’re just in stocks but with the annual reset feature that protects you, I mean, one of the equitable index products whether that be more of the annuities or life insurance contracts, you get locked in. So, you stay up at 10% while everybody else goes down 5%. Then in year 3, the market is up 8% and you just captured yourself up to 20% that year.

And then in year 4, the market goes down an entire 18%. Look you’d be almost down in just having 2% left of all those earnings just because the market decided to go (poopoo) with that one year. And we know that that can happen overnight. If you just think back to 911 or 912, one geopolitical event knocked the market down by 50% so losing something like 18% could happen just by waking up in the morning.

And here you have that type of situation where here you would be down but not with one of these products. The dynamic loan provision protects you from downside market risk and you would stay up at your 20%. So, you are always starting where the market creeps its way back up.

You’re never taking that roller coaster ride down. It’s something out of roller coaster that continues its ride upwards. So, let’s reiterate some of the ideas of this: 5% S&P 500 Index growth times by 140% of the participation rate which gives you about 7% credit into your cash values which are the little account that’s built up inside the policy that exceeds the cost of the insurance.

Then if you would take a dynamic loan provision back to yourself, you would get that little spread that 2.35 that we saw which generates a 9% internal rate of return in the policy.

If over time we look at what the internal insurance cost usually get down to, it’s about a half a point and we subtract that from that 9% internal rate of return. Then you have an approximate 8.5% of internal rate of return and that’s what’s you’re earning on your money probably by the time you get to your 10 with your policy. So, how can insurance companies do this you may be asking yourself?

I’m going to show you in an illustration real quickly on how that works. You have the insurance company and you have premium expenses which are to insure you and you make those payments and out of those payments, they invest in corporate grade government bonds.

And with the interest that’s spun off of those corporate bonds, they buy options both puts and calls on the S&P 500 and that produces 140% gains to a maximum of 10% which is capped on those options. And then those then spin off interest and they’re used to go and buy more bonds and it becomes quite cyclic and that’s why they’re able to go out and credits you 140% of the gains.

The bonds provide the principal guarantee. Interest pays for the option spreads and the option provides the yield that ultimately you inherit with you cash values.

So, here’s a retirement income comparison. Here are the assumptions: You have a mutual fund match market with dividends, 1.75% covering expenses, 100% of the mutual fund gains are subject to long-term taxation and there’s no dividends paid on life policy.

You got $25,000 away per year and an investment premium for 10 years and your retirement income that will begin in year 20. So, how does that match up the index life with your typical mutual fund? And we’re going to now look at various interest rates that would be spun off because really interest rates have a powerful and profound effect on what you ultimately have in your retirement income.

So, let’s take a look at how this plays out at 4%. At 4%, that mutual fund will return to you $13,000 and that’s over the 20-year cycle.

Now, that index fund because of the tax preservation, the preservation of principal, you’re looking at earning around $35,000 so that same amount of money. That’s almost double.

Now, if we just ratchet things up just one more percentage point and you happen to average out earning 5% on your money. That mutual fund will give you $18,483. But the index fund would be able to yield $69,409. Again, almost double the results of what the mutual fund is capable of doing because it’s held down due to the expenses and taxation.

Now, if we just ratchet things up one more percentage point to 6%, it’s probably doable. It’s an average 6% over time. And your mutual fund would give you $25,000. You’ve kind of now almost doubled your money in a 20-year period. But with the equity index Universal Life product, you’re looking at $113,000 practically quadrupling your income.

So, when you’re thinking about retirement, isn’t the idea to capture the highest interest rate you can earn more so that you can outpace inflation and try and reduce and get away from as much taxation? Sure it is, absolutely.

Those are the ideas and those are the things that you have to strive to achieve. John Bogle says avoid financial advisors who claim they can predict and advance top performing managers. The best advisors can help you develop a long range investment strategy, an intelligent plan for its implementation. An intelligent plan is going to incorporate the things we just discussed.

It’s going to help you maximize your interest rates. It’s going to help you outpace inflation and it’s going to reduce or eliminate taxation on those funds.

That’s all I have for you today and next time we’re going to be looking at another life insurance strategy for either your retirement or your business planning. Until next time, thanks again for joining us.

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Life Insurance Basics Explained – Life Insurance 101

Life Insurance Overview

Insurance began as a way of reducing the risk to traders, as early as 5000 BC in China and 4500 BC in Babylon. Life insurance dates only to ancient Rome; “burial clubs” covered the cost of a member’s funeral expenses and helped survivors monetarily; this is akin to modern day final expense insurance to cover burial and memorial services.

The first insurance company in the United States was formed in Charleston, South Carolina in 1732, but it provided only fire insurance. The sale of life insurance in the U.S. began the late 1760s and eventually paved the way to NY Life.

There are three basic questions in life insurance, two types and two uses that should be understood so that there is a tailored approach.

The Three Threshold Questions

  • Do I need Life Insurance?
  • What kind?
  • How much?

Two Types

  • Temporary – Term Life Insurance
  • Permanent – Whole life, Universal Life, Variable Universal Life

Two Uses

  • Lifestyle Capital – this is insurance with cash values and reduced death benefit so that the insured takes advantage of the tax code under IRC 7702 which allows tax deferred build up of additional funds and then access to the funds tax-free as loans.
  • Succession Capital – this is where the death benefit is used to create a legacy or pay business expenses, infuse a company because the figurehead died or pay estate taxes for larger estates. The best techniques for this is premium finance where the insured uses a loan to pay the insurance premiums much like you would take out a home loan you’re taking out a policy loan to retain capital and not disrupt investments yet gain the coverage you need.

Life insurance Basics 101 – Video Transcript

Hi, me hearties. I want to sell you some life insurance, I do mate. Hi, this is James Burns. I’m trained as an attorney and I do life insurance and I’m here with Rob Lambert and his Asset Protection Training. Why did we design this for you? Well, so that you ( 00:00:20) you’re coming up against a pirate who may be trying to sell you inappropriate or unsuitable life insurance. The reason I got involved in it was I was doing the estate planning and for years I would encounter folks that were selling insurance to my clients and they don’t know what they were doing. They had several years in the industry and still didn’t know what they were doing. Now, the industry makes them do continuing education but for some reason some of these guys just seemed warm through and, you know, it’s always shocking to me when I encounter one of them that’s been doing it for 20 years and they still don’t know fundamental concepts.

So, as a result of that I’ve decided I should be out there doing it and kind of put the legal practice aside and just to help folks understand life insurance, keep them away from the pirates. I feel like the colonial marauder out there trying to chase down the pirates basically and help folks get the suitable products that they need. Now, we think of life insurance. There’s really three fundamental questions that come to mind and it’s what type do I need and how much. Those are really ( 0:01:25) questions and most it is done with a financial needs analysis where an insurance professional is going to come to you. They’re going to takes notes about your specific situation and from there they’re going to design a product and/or ( 0:01:39) products that fit your situation.

Next, you need to know that we have it for two main purposes. One is U.S. ( 0:01:46) to your business. Life insurance work as a continuation planning case as the CEO or a key person in a company wants to go down either they become disabled or they pass away. We often need life insurance in there as a resource for cash and we’ll talk about how you build up cash values inside that policy just beyond that death benefit. So, in other words, there’s a way to use it for payment to yourself rather than you dying. The ( 0:02:16) such a thing as life insurance and that means you’re able to used it while you’re still alive. It’s not just something that you’re going to pass down to your loved ones and you have to become an angel for them to get it and for it to become useful.

Well, ( 0:02:32) aspects of insurance, it’s been around for centuries and ( 0:02:37) 5,000 B.C. many of merchants travelling ( 0:02:41) road to China would ensure their trip. We find life insurance seems to have evolved around the Roman Empire and they had a thing called the Burial Club which would cover the cost of funeral processions and memorial services as well as the plots for ( 0:02:58). In modern times, which means currently today, we have a practice very similar to that called final expense. It’s a small ( 0:03:07) and a group of individuals called the National Association of Funeral Directors have determined with statistics that the cost of burial and memorial services is somewhere between $10,000 and $30,000 depending on what locality of the country you live in. But for most people they should have at least that small policy of $30,000. Now, going back to that need ( 0:03:31) we need to understand the different types of life insurance practice out there so we’ll know what is the appropriate fit for us.

First, we start with the one that a lot of people are familiar with ( 0:03:42) is called term. Term life insurance is temporary. That means that you’re buying it ( 0:03:48) and most of those products will go for 10 years, 20 years, 30 years. Now, if you had a mortgage and most mortgages are 30 years long and you wanted to provide some life insurance protection for that mortgage duration, which one would you get? That’s right. I can hear you out there. You would want that 30 years. However, sometimes the cost of a 30-year term policy could be such that it doesn’t fit your budget. So, the question is can I afford? Can I add ( 0:04:20) monthly so that I can afford this product?

Next, we have permanent life insurance and there’s a couple of different varieties in the permanent life insurance. First, is whole life. Now, whole life can be a little bit more expensive than term ( 0:04:38) is that it’s probably five to 10 times more expensive. Why? Because you’re buying it for the duration of your life and that means you’re going to be gone beyond that 10, 20 or 30 years possibly. Hopefully, you’re going to be living a long life and you’re locking in a price a today for the duration of your lifetime as well as you’re going to build up what’s called cash values. It’s like a little account that’s attached to your life insurance policy. If we were to look it up like this. Here you have your life insurance and here you have this account that will build up cash values. What’s the significance of these cash value accounts?

Well, you’re able to access that cash tax free to yourself. It will build up tax deferred and you can tap those funds tax free under a long provision that’s in the policy. As you well know, anytime you take out a loan, access to those proceeds are tax free. The cost inside that whole life policy again may be very expensive. You’re not sure where the life insurance company is going to be investing and so that becomes problematic. The next vein of the permanent life insurance is universal life and universal life also is referred to flexible life and it seems to have come around in the 1980s and what those products allow you to do is be a little bit more flexible in terms of your monthly payments. In other words, if I was paying $300 a month I could decide around the next month that I only have $200 in flexible payments as well as the death ( 0:06:16), the amount that’s paid out to your loved ones could remain level. It could remain increasing or it keeps going up based on the amount of payments that I feel like ( 0:06:25).

Next, we find variable universal life. Same thing as universal life only the investment aspect of this is going to be tied to the market which means we’re going to invested in the stock market and we’re going to be invested in the mutual funds. The good side of that is you can get some of that high upside gains in the market when it’s happening which we haven’t seen ( 0:06:49) now. And the bad side of that is that when the market is down, so are those cash values which mean they might not be there to cover payments on your policy. So, most people find out in the long-term that variable universal life policy doesn’t do them justice.

Finally, the one that’s become very very sought after right now is the equitable ( 0:07:18) life and it’s because of investment strategy. In the ( 0:07:22) and financing, there’s really three different types of investment strategies just to keep it simple. There’s fixed and that’s like when you go and get a CD and you know what your rate is. You’re going to get your 1.1% out there. Then ( 0:07:36) market affixed or market affixed type of strategy where you’re going to be subject to whatever the stock market is doing or the mutual funds. Sometimes that’s going to be up, most time that’s going to be down and you’re going to taking the roller coaster ride according to your tolerance. And then the third type of investing strategy is with an index. And let me explain how the index works relative to universal life products.

With ( 0:08:03) index, you’re going to capture whatever the S&P 500 does and as you know, index is we have the S&P 500, the Dow Jones Industrial average and the NASDAQ as well as many other ( 0:08:15) but these are really the three biggest ones that we hear a lot in American press. These products are designed to go along with the S&P 500 which is 500 of the largest companies in every kind of sector so ( 0:08:29). In fact, index investing becomes one of the best places that we can ever make in terms of getting involved in the market. Now, with these types of policies, you’re going to lock in your gains as the market is moving up. When the market goes down, you’re staying right here. You’re locking in your gains. You’re never going down. So, it has downside risk avoidance.

Here’s what happens folks for most people who are trying to go a long distance for investment purposes is they ride that roller coaster ride and then the day when ( 0:09:03) that age for retirement, they may be down here which means on the bottom side of their roller coaster ride. Think about this for a moment ( 0:09:12) a 911 or perhaps 912, the day after and the market was down over 50%. How much of your funds would you have to be able to access? It will be dependent on how much you put away for years but just knowing that you’ll be at least cut in half by one geopolitical event would be devastating. With this type of product, you’re locking in your gain ( 0:09:37) and we want to stress that on ( 0:09:39) it is because the stock market is an unreliable indicator. It’s kind of like gambling in most aspects.

So, imagine how locking in the gains and when it begins ( 0:09:50) again, you’re starting from where you left off. So, there is an old adage, when does a negative 30 plus ( 0:09:57) equals zero and that’s anytime that the market goes down ( 0:10:06). You have to get back to at least 43% just to get back where you started. So, imagine doing that several periods of time during the 30 to 35-year period which is the typical duration for retirement. So, what I’m just telling you right now is ( 0:10:24) insurance product could be a savings type of investment for you. Not only will it provide that death benefit for your loved ones but it is a way to save up tax deferred and then access those funds tax free ( 0:10:41) retirement years.

Now, imagine doing that every year in your retirement being completely tax free. Do you think that ( 0:10:49) into this deficit and the way we’re going to fund the Healthcare Reform Act that taxes aren’t going to go up? If you do ( 0:10:58) true but the facts are folks that taxes are going to go up and you’re going to need a tax free strategy retirement ( 0:11:09) this, your typical IRA and the 401(k) is taxed at ordinary income at the point of retirement. So, whatever year you decide to retire at 65 typically, you start getting taxed at whatever tax bracket you’re in at that particular point and sometimes that can be quite devastating especially if you were planning to retire in a lower tax bracket. It’s almost inevitable that you will be retiring in a higher tax bracket. So, again, you want to look at a tax free strategy.

So, life insurance has it’s aspect of covering risk, taking care of our loved ones and replacing income if we’re ever gone and while we’re still alive we can access this cash values, this tax advantage savings account tax free and ( 0:11:58) that income, you know, retirement years. So, in subsequent installments, I’m going to take you through a journey of understanding at least 100 different strategies for both personal and business and sometimes when you’re just a foreign individual residing here in the United States ( 0:12:16) instances in both your estate plan and your business where you also need to think about plugging your life insurance to just cover ( 0:12:23) could be devastating to you, your family or your loved ones.


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