whole life comparison with BTID
Rock
participating whole life policy and a BTID (buy-term,
invest-difference) equivalent.
Please comment on any points which interest you. I am looking for
negative feedback more than positive -- positive makes me feel good,
but negative makes me rethink the issues.
My primary goal is to have the comparison be as "fair" as possible,
knowing ahead of time that everyone who views my site will have a
different take on what is fair. The new model is using the VBIIX high
quality bond fund within an IRA as the investment portion. In a
previous thread, I decided that a 6.75% annualized rate would be a
justifiable number for return in future years (past years will use
actual "total return"). The BTID model is using a bond fund because
most of the investment gain within my policy will be from bond
earnings within the general account of NYLIC. If my policy were
variable life, then the BTID model would use fund(s) equivalent to the
separate accounts used by the policy. Since a par. whole life policy
is conservative by design, I believe modeling it against a stock
market index is an unfair comparison.
A big bugaboo in the comparison is taxes. I believe this to be true
even if withdrawals are not considered from either the policy or the
fund. Do I understand correctly that life insurance companies pay
ongoing taxes (income, differential earnings, etc) that, if not needed
to be paid, would increase the return to the policyholders? In
comparison, the earnings of the mutual fund do not seem to experience
a similar indirect taxation. The fund company pays taxes on profits,
but their profits are legally separated from shareholder earnings on
the underlying investments. What the fund pays taxes on is profit
from fees, loads, etc, not investment earnings.
My point is the investment earnings of a life insurance company are
taxed in a way invisible to policyholders, but earnings of a mutual
fund are completely passed to shareholders, who will be directly taxed
on capital gain or other taxes. Investments within IRAs, 401k's,
annuities, and life insurance policies receive tax deferral on
earnings, but when money comes out, it is taxed. Assuming this is all
correct, it seems that shareholder earnings are only taxed once,
whereas whole life insurance earnings are taxed two ways. (Only one
way if the insured dies, though.) Am I correct concerning these tax
issues? Are they relevant?
If I am not off base, here is what I think models the BTID.
0) A single 30-year term policy will be used, annual
premium $485. The ages modeled are 42-99, with the
insurance dropped at age 71.
1) VBIIX investment receives tax deferral in IRA.
2) At age 70.5, principal and earnings have to start
coming out of the IRA.
3) The investment will be transferred to a tax-free
municipal bond fund, spread evenly over a period of 20
years (age 71 to 90).
4) The muni fund will be given a 5.9% annualized return.
5) Transferred gross earnings will be subject to ordinary
income tax at a 15% rate. (Only the money actually
transferred in a given year is taxed.) What the model
will actually do is not tax the transfer for the first
several years, then tax for the remainder of the 20
years. This is to avoid taxing the investment basis.
(If VBIIX had been in a 401k, I believe the basis would
be $0, hence it would be taxed for all 20 years.)
6) Once in the muni fund, the investment becomes tax-free,
not merely tax deferred.
I had thought that a Roth IRA would be the better tax-advantaged
vehicle for this model. It certainly is simpler (no transfer is
necessary, and money can remain in VBIIX thru age 99). I decided the
Roth introduces several inequalities. First, if money is taken out,
it would be tax-free on the Roth, but merely tax-deferred on the
policy. Second, not everyone is eligible for a Roth. Third, if money
stays inside the two models, earnings are being indirectly taxed on
the policy, and not taxed within the Roth.
Do you believe the above constitues a fair rationale and basis of
comparison? Or is it a contrived rationalization of a really weird
guy with incomprehensible motives? (Don't feel you have to pass
judgement on the whole thing; individual points are open for
critique.)
Here are some of the remaining inequalities:
A) Death benefit passes income-tax free to beneficiary,
but BTID investment will be income to heir(s).
B) ("I think.") Policy income is indirectly taxed every
year, but BTID income is only taxed during the xfer.
C) Once transferred to the muni fund, the investment
earnings will not be taxed again. Policy earnings
will eventually be directly taxed if I don't die first.
D) Loans can be taken on the policy, but not the IRA.
(If I die with an outstanding loan, the policy escapes
taxes, but the loan will have been paying interest.)
E) The 15% tax rate during the BTID transfer is probably
a little low. The 5.9% earnings rate on the muni fund
may be a bit high. (Both are so far in the future, it
is really hard to know what will end up to be
reasonable.)
Do you feel the inequalities are significant? If so, do you have any
suggestions to make the model fairer? Are there factors I have
overlooked?
-- Rich
--- The Visible Policy
---- http://dbatitan.home.att.net/vp/
Beliavsky
>participating whole life policy and a BTID (buy-term,
>invest-difference) equivalent.
I am not an insurance expert, but it seems to me that comparing BTID with whole
life is very difficult, because they differ in more fundamental ways than
taxation. When you own shares in a mutual fund, your investment is segregated
from the capital of the fund company. With a whole life insurance policy, there
is only the "general account" of the insurance company. Furthermore, with BTID
you can choose your investments, probably choosing more conservative funds as
you get older, but with whole life, the general account is supposed to be
invested in the way that is best for policy holders as a whole, not you in
particular.
I think BTID is much closer to variable universal life (VUL), so why don't you
compare those two? With VUL, you allocate your money across subaccounts, many
of which have managers that also manage mutual funds. Ben Baldwin compares the
tax treatment of mutual funds, annuity subaccounts, and VUL subaccounts on
pages 123-4 of "The New Life Insurance Investment Advisor". He points out that
money in VUL subaccounts grows tax-free, that the cost basis can be withdrawn
tax-free, and that a VUL policy can be borrowed against
tax-free. I am pretty sure that the insurance company is NOT taxed on the
earnings in your account. After all, it is your gain, not theirs. Furthermore,
if your high-yield bond sub-account yields 12% and the Federal government taxed
the insurance company on that income, there is no way the insurance company
could credit you with a 12% gain on the sub-account. It would go bankrupt.
Here is what Maginn & Tuttle say about taxation of life insurance companies in
their book "Managing Investment Portfolios", 2nd edition (1990), p4-52:
"In a very simplified context, invest income of life insurance companies is
divided into two parts for tax purposes:
(1) the policyholders' share -- that portion relating to the actuarially
assumed rate necessary to fund reserves
(2) the balance that is transferred to surplus. Under present law, only the
latter portion is taxed."
This passage suggests that whole life insurance are not taxed on all the
investment gains of their portfolio, only the portion that exceeds their
actuarial assumptions.
Many states tax life insurance premiums, at rates ranging from 0.5% to 3.5%.
OTOH, there are no state income tax and capital gains taxes on the growth of
your
insurance account each year.
It would take someone far more knowledgable than me about life insurance
company taxation to definitively answer your questions. Where is Brent Gardner
when you need him :) ?
Rock
> I am not an insurance expert, but it seems to me that comparing BTID with whole
> life is very difficult, because they differ in more fundamental ways than
> taxation. When you own shares in a mutual fund, your investment is segregated
> from the capital of the fund company. With a whole life insurance policy, there
> is only the "general account" of the insurance company. Furthermore, with BTID
> you can choose your investments, probably choosing more conservative funds as
> you get older, but with whole life, the general account is supposed to be
> invested in the way that is best for policy holders as a whole, not you in
> particular.
Excellent points. Consider them appended to the "remaining
inequalities" section of my original post.
> I think BTID is much closer to variable universal life (VUL), so why don't you
> compare those two?
The primary purpose of The Visible Policy site is to fully documemnt
my own participating whole life policy. The comparison with BTID is
an "extra" that I add in an attempt to pre-answer a question which may
be in a visitor's mind. Since I am documenting my policy, the BTID
comparison is with my policy. I hope to make the BTID model as close
a match as possible.
http://dbatitan.home.att.net/vp/
Once I finish revising the model, the spreadsheet with which it is
built will be downloadable. If someone wishes to revise the various
parameters, they can do so. I can tell you right now that if commonly
stated equity returns are plugged in instead of bond returns (9%
rather than 6.75%), the BTID case will significantly outperform the
whole life policy. But if one desired the conservatism and guarantees
inherent with a whole life policy (as I do), modeling against an
equity instrument is just plain silly.
The spreadsheet has a return-rate column for each year, so if you
wanted to check out a strategy of fairly aggressive in early years and
more conservative in later years, you could. Of course, you'd have to
acquire your own VUL policy to compare this BTID against. :)
> ... I am pretty sure that the insurance company is NOT taxed on the
> earnings in your account. After all, it is your gain, not theirs.
One would think it is my gain, but Congress has decreed otherwise. It
is the mutual insurance company's gain, some of which is credited to
my policy. The gain (and even the principle) are not mine until such
time as I request a cash disbursal or lapse the policy. The
difference is significant when compared to mutual funds. In a mutual
fund, it is your principal and gain. Someone suing the mutual fund
company has no legal claim on the fund-holder's assets. Someone suing
a mutual life insurance company, on the other hand, does not need to
differentiate between assets held in the general account and other
assets of the insurance company.
> Here is what Maginn & Tuttle say about taxation of life insurance companies in
> their book "Managing Investment Portfolios", 2nd edition (1990), p4-52:
>
> "In a very simplified context, invest income of life insurance companies is
> divided into two parts for tax purposes:
> (1) the policyholders' share -- that portion relating to the actuarially
> assumed rate necessary to fund reserves
> (2) the balance that is transferred to surplus. Under present law, only the
> latter portion is taxed."
>
> This passage suggests that whole life insurance are not taxed on all the
> investment gains of their portfolio, only the portion that exceeds their
> actuarial assumptions.
Thanks. Ok, not all of the investment gain is taxed. Some is.
Within a mutual fund, none of the investment gain is taxed until
distributed to fundholders. As part-owner of the mutual insurance
company, it would seem I am in fact being taxed. I don't know what
proportion is classified as "reserves" and what is classified as
"surplus". I don't even know who sets the proportions -- the
insurance company or the government. If it is the insurance company,
one would think they would say it is all "reserves", avoiding this tax
completely.
Investment gains are only part of what is taxed. There is also a
"differential earnings" tax which mutual insurance companies must pay.
Apparantly in 1984, the stock insurance companies told Congress that
mutual insurance companies had an unfair advantage. The stock
companies had to provide earnings to both the policyholders and the
stockholders. The mutual companies only had to provide earnings to
policyholders. So, in the interest of "levelling the playing field",
Congress decided to tax the mutuals on the difference that they don't
have to pay to stockholders. The tax is apparantly applied to
dividends received via some formula that only an accountant could
love.
I can't wait until commercial banks complain to Congress about mutual
funds. The poor banks have to provide return to both their CD
customers and to to their stockholders. The mutual funds only have to
provide return to the fundholders. By all means, keep the playing
field level. Mutuality is obviously a communist concept anyway...
> It would take someone far more knowledgable than me about life insurance
> company taxation to definitively answer your questions. Where is Brent Gardner
> when you need him :) ?
But, but, Brent has opinions. He is not a "just the facts" guy like
me. ;)
-- Rich
--- Life Insurance GlossPinion
---- http://home.cfl.rr.com/rickyworld/vp/glosspinion.html
Brent D. Gardner ChFC
>Where is Brent Gardner
>when you need him :) ?
I started moving my home on Monday, then my office on Tuesday. I'm still
unpacking at home and the office will take another week...
...but I will return! =)
Brent D. Gardner, ChFC
Chartered Financial Consultant
The aforementioned message is for informational purposes only and is not a
solicitation for securities or insurance. No advisor-client relationship has
been established.
Rock
critique my BTID assumptions? They can be found on Google Groups
here:
http://groups.google.com/groups?selm=3947f9dd.0208011340.739a31db%40posting.google.com
Tad? Ed (not J not Z)? Anyone, partisan or not? (BTW, I don't mean
anything bad by "partisan".)
I am trying hard to take a balanced stand on the issue. Without
input, though, all that results are the contents of my own head and
spreadsheet.
Maybe if you had some more ammunition... Take a look at my updated
"Inflation Wave" page, representing the new model and BTID
assumptions:
http://dbatitan.home.att.net/vp/vl07.html
It contains policy lifetime curves for both Total Cash Value and Death
Benefit. Several strategies are illustrated:
participating whole life as illustrated by NYLIC
par. WL with extra premiums paid for more years
par. WL with OPP payments ("overfunding")
min BTID (or "T+I", same cash outlay as 1st case)
max BTID (or "T+I", same cash outlay as 3rd case)
To show that my results are more balanced than they used to be, here
is a link to the same page, but with my original model:
http://dbatitan.home.att.net/vp/vl07orig.html
My site still has 3 pages to update using the new model (3, 4, 5 and
A1). Before I do so, it would help immeasurably to get other opinions
and critiques. Thanks!
Rock
> ... Ben Baldwin compares the
> tax treatment of mutual funds, annuity subaccounts, and VUL subaccounts on
> pages 123-4 of "The New Life Insurance Investment Advisor". He points out that
> money in VUL subaccounts grows tax-free, that the cost basis can be withdrawn
> tax-free, and that a VUL policy can be borrowed against tax-free.
I missed this point in my first reply. Do you/Ben mean "tax-free" or
"tax-deferred"? It is my understanding that gains on any cash value
life insurance are only tax-deferred. Well, unless you die first.
;-) If you take money out while living, the gain is ordinary income,
not capital gains, right?
(If I am wrong about this concerning whole life policies, my BTID
model should probably go back to using a Roth rather than a regular
IRA.)
The one part I am not puzzled about is "borrowed against tax-free".
This fits with my understanding. Although you are not paying taxes,
you are paying interest to the insurance company. So even here,
"tax-free" needs a footnote.
You also mentioned that many states charge a small tax on premiums.
Does anyone know about how many states do so? Does the premium tax
only apply to premiums paid out-of-pocket, or is it still applied when
the premiums are being paid by
dividends/earnings/accumulated-cash-value?
Do any states charge a tax on money going into IRAs or Roth IRA's?
Fortunately I live in Florida. To the best of my knowledge, it does
not have any of these kinds of taxes.
-- Rich
--- http://rocq.home.att.net
Beliavsky
>"tax-deferred"? It is my understanding that gains on any cash value
>life insurance are only tax-deferred. Well, unless you die first.
>;-) If you take money out while living, the gain is ordinary income,
>not capital gains, right?
Let me quote Baldwin verbatim and let you draw your own conclusions. On p124 he
writes
"The capital inside a life insurance policy has the same features of the
annuity contract [meaning that it grows tax-deferred]. In addition, you can get
the money out of your policy any time without taxation and penalties (before
age 59 1/2) as long as you have adhered to the seven-pay limitations (discussed
in Chapter 8) on how much you can invest into the life insurance policy. You
can withdraw from your policy up to its cost basis (what you put in) without
income taxation, and also borrow against it without income taxation."
Since the cost basis includes some money that has been used to buy the term
component of the insurance policy, you are effectively buying some term
insurance with pretax money.
P.S. You have a nice web site on whole life insurance.
TTRoberts
<< <I>My point is the investment earnings of a life insurance company are
taxed in a way invisible to policyholders, but earnings of a mutual
fund are completely passed to shareholders, who will be directly taxed
on capital gain or other taxes. Investments within IRAs, 401k's,
annuities, and life insurance policies receive tax deferral on
earnings, but when money comes out, it is taxed. Assuming this is all
correct, it seems that shareholder earnings are only taxed once,
whereas whole life insurance earnings are taxed two ways. (Only one
way if the insured dies, though.) Am I correct concerning these tax
issues? Are they relevant?</I> >>
No, I don't feel the "invisible" taxes you're referring to has any relevance to
the comparison that you're doing. What's you're comparing are the direct
effect of the decision to BTID or buy a WL contract.
<< <I>If I am not off base, here is what I think models the BTID.
0) A single 30-year term policy will be used, annual
premium $485. The ages modeled are 42-99, with the
insurance dropped at age 71.</I> >>
Using an annual level term premium is very often used to try to keep things as
simple as possible. However it's not a good way for a comparison as the COI
(cost of insurance) within a WL contract is NOT level. It's not that hard to
get numbers that might be more realistic where the COI is increasing in your
model for the BTID side of your Franklin "T".
If the insurance is going to be dropped at age 71, then you'll need to do the
same for the Whole Life contract. And if one is going to do this with the
Whole Life contract, then BTID wins as a WL contract is supposed to be kept for
one's entire lifetime and works best when done so.
<< <I>1) VBIIX investment receives tax deferral in IRA.</I> >>
In doing a comparison, using some form of tax-deferred vehicle helps give a
good equivalent comparison.
<< <I> 2) At age 70.5, principal and earnings have to start
coming out of the IRA.
3) The investment will be transferred to a tax-free
municipal bond fund, spread evenly over a period of 20
years (age 71 to 90).</I> >>
Sounds fine as long as one is accounting for the taxes paid on what's coming
out of the IRA as well as the taxes related to other income (e.g. social
security) that is effected by the increase in taxable income for a retiree.
<< <I> 4) The muni fund will be given a 5.9% annualized return.</I> >>
If that's an historical average . . . it's fine too.
<< <I> 5) Transferred gross earnings will be subject to ordinary
income tax at a 15% rate. (Only the money actually
transferred in a given year is taxed.) What the model
will actually do is not tax the transfer for the first
several years, then tax for the remainder of the 20
years. This is to avoid taxing the investment basis.
(If VBIIX had been in a 401k, I believe the basis would
be $0, hence it would be taxed for all 20 years.) </I> >>
See my comment on item 3 & 3.
<< <I> 6) Once in the muni fund, the investment becomes tax-free,
not merely tax deferred.</I> >>
Sound fair to me.
<< <I>I had thought that a Roth IRA would be the better tax-advantaged
vehicle for this model. It certainly is simpler (no transfer is
necessary, and money can remain in VBIIX thru age 99). I decided the
Roth introduces several inequalities. First, if money is taken out,
it would be tax-free on the Roth, but merely tax-deferred on the
policy. Second, not everyone is eligible for a Roth. Third, if money
stays inside the two models, earnings are being indirectly taxed on
the policy, and not taxed within the Roth.</I> >>
Hmmmm??? Why not do a Roth too?
<< <I>Do you believe the above constitues a fair rationale and basis of
comparison? Or is it a contrived rationalization of a really weird
guy with incomprehensible motives? (Don't feel you have to pass
judgement on the whole thing; individual points are open for
critique.)</I> >>
I feel it IS a good effort. However, what I feel makes a really good
comparison is one that speaks to VERY specific objectives of an individual.
One comparison may favor someone who feels they'll want to use 100% of the
money. While another may favor someone who has no plans on using ANY of this
money as there are other resources for income. A comparison of this sort tends
to be very generic though it IS helpful in understanding some of the
relationships between the two methods.
<< <I>Here are some of the remaining inequalities:
A) Death benefit passes income-tax free to beneficiary,
<b>but BTID investment will be income to heir(s).</b></I> >>
Only the amount coming out of the IRA will be income to heirs. There other
tax-free muni-bind fund will not and it will also receive a step up in basis
for the heirs.
<< <I> B) ("I think.") Policy income is indirectly taxed every
year, but BTID income is only taxed during the xfer.</I> >>
No, forget the "indirect tax" . . . it's not going to be part of the
policy-owner's tax return.
<< <I> C) Once transferred to the muni fund, the investment
earnings will not be taxed again. <b>Policy earnings
will eventually be directly taxed if I don't die first.</b></I> >>
Policy will not have "earnings". But when a policy lapses or is surrendered
with cash value greater than total premiums paid, then the difference is taxed
as realized income. So, as I said, if the plan is to surrender the policy at
age 71, a WL contract is at a distinct disadvantage since it's designed to kept
till one dies.
<< <I>D) Loans can be taken on the policy, but not the IRA.
(If I die with an outstanding loan, the policy escapes
taxes, but the loan will have been paying interest.)</I> >>
Correct. But note: Not only will the loan be generating interest charges, the
amount that is loaned will also be earning interest . . . but at a different
rate. The net interest cost is the difference between these two rates and are
often somewhere around the 2% range. Some of the better contracts are much
less and some net interest costs are more. If someone is planning to use
policy loans to supplement an income flow, this can be a very important issue.
<< <I> E) The 15% tax rate during the BTID transfer is probably
a little low. The 5.9% earnings rate on the muni fund
may be a bit high. (Both are so far in the future, it
is really hard to know what will end up to be
reasonable.)
Do you feel the inequalities are significant? If so, do you have any
suggestions to make the model fairer? Are there factors I have
overlooked? </I> >>
As you suggest, the future is really an unknown. So about all you can do is to
go on historical data. That's why I suggest using a historical average of the
muni-fund. Any comparison like this only fits a certain set of assumptions.
As long as you recognize and are clear about those assumptions and how they
relate to the objectives, the comparison should be valid. You'll always have
individuals who'll have very different objectives AND are willing to make very
different assumptions.
Therein, differences of opinion arise. But that doesn't mean what you're
doing doesn't help clarify things. So, keep up the effort . . . . it seems
worthwhile to me. ;-)
TTRoberts
<< <I>I missed this point in my first reply. Do you/Ben mean "tax-free" or
"tax-deferred"? It is my understanding that gains on any cash value
life insurance are only tax-deferred. Well, unless you die first.
;-) If you take money out while living, the gain is ordinary income,
not capital gains, right?</i> >>
Yes. Anything you "take out" that is in excess of total premiums paid IS taxed
as ordinary income . . . NEVER capital gain.
Loans are loans and are not taxed. However, when a policy lapses or is
surrendered with outstanding loans, then those outstand loan amounts are
consider to be money that has been "taken out" and treated accordingly.
<< <i>The one part I am not puzzled about is "borrowed against tax-free".
This fits with my understanding. Although you are not paying taxes,
you are paying interest to the insurance company. So even here,
"tax-free" needs a footnote.</i> >>
Generally, I would argue that using the term "tax-free" is inappropriate as it
too easily and too often leads to misunderstandings. Rather than using the
term "tax-free" it seems to me it would be better put by simply saying
"borrowed against where loans aren't taxed". But then one needs to make the
point that if the loan(s) are not paid back and the policy is surrendered or
lapses, then those amounts in excess of total premiums paid ARE taxed. Yes,
it's easier to just say "tax-free" . . . but that very often leads the less
knowledgeable to incorrect conclusions . . . or a least some confusion.
<< <I>You also mentioned that many states charge a small tax on premiums.
Does anyone know about how many states do so? Does the premium tax
only apply to premiums paid out-of-pocket, or is it still applied when
the premiums are being paid by dividends/earnings/accumulated-cash-value?<?I>
>>
As far as I know . . . ALL states have a "premium tax" that is levied by the
state the policy was sold in and collected by the insurance companies. But the
sizes of this tax varies from state to state and can run around 2% to 3% of the
premium that's paid "out-of-pocket. For some states it's less, some are more.
This "premium tax" is built into the model premium payment you make. In
variable contracts, the amount is broken out just as other costs and expenses
are to see.
Keep in mind that a dividend is money in your pocket. You choose how to use
those dividends. Therefore when you elect to apply dividends to premium
payments, YES . . .they pay the "premium tax". I don't exactly remember, but
it seems to me that even when one is using the dividend option to purchase
paid-up-additions, the premium tax is included there as well since you're
purchasing additional life insurance.
This "premium tax" is collect by the state in order to insured that if the
insurance company goes belly-up, people with life insurance will be guaranteed
the death benefit will be paid no matter what. In effect, you're paying to
insure the insurance company.
<< <I>Do any states charge a tax on money going into IRAs or Roth IRA's?
Fortunately I live in Florida. To the best of my knowledge, it does not have
any of these kinds of taxes.</I> >>
Hopefully, my explanation of the "premium tax" shows why there's really no
correlation here. There's no death benefit in an IRA to insure . . . so why
would there be such a tax on money going into any type of IRA??? ;-)
Ed Zollars
>Generally, I would argue that using the term "tax-free" is inappropriate as it
>too easily and too often leads to misunderstandings.
I would note that I've seen problems with that outside the insurance
context as well. For instance, I've heard some invested in real estate
refer to fund received by refinancing the property and taking cash out as
"tax free" funds. Unfortunately, too often these same people are shocked
to find that those "tax free" funds created loans that are paid off when
the property is sold--and that they may find they now owe tax on the sale
of the property without a corresponding amount of cash left over to pay
them after the mortgage is paid off.
So I do tend to correct anyone, in any type of investment, who uses the
term "tax free" inappropriately. Tax free needs to be limited to truly
"never to be income taxed" types of income and cash flow, such as the death
benefit from a life insurance policy, municipal bond interest and qualified
distributions from a Roth IRA.
---
Ed Zollars, CPA (AZ)
http://www.hmtzcpas.com
Tad Borek
> Are there no "but term & invest the difference" partisans willing to
> critique my BTID assumptions? They can be found on Google Groups
> here:
>
> http://groups.google.com/groups?selm=3947f9dd.0208011340.739a31db%40posting.google.com
>
> Tad? Ed (not J not Z)? Anyone, partisan or not? (BTW, I don't mean
> anything bad by "partisan".)
I thought you said "Parisian," so I didn't reply.
No seriously, the BBAG page has exceeded my MIFP time budget so
I'll just reply to random things from that google
link...generally, I think an issue you have is that there's a big
range to the assumptions so you just need to pick something & go
with it. If you can befriend an insurance mole, or troll industry
reports, maybe they can give you some data to help. Anyway:
Choice of fund - you'd hope that if you BTID you'd pick something
more aggressive, and more tax-advantaged, than a bond fund in an
IRA that's invested for as many years as you're suggesting. Maybe
you need to go with this, but if someone wants financial security
many years from now you'd think the topic of stocks (and the
inflation problems of bonds) would come up, ya?
Taxation of insurance co - Insurance companies are
specially-taxed entities. Maybe post to a tax NG and you'll find
someone versed in the specifics. There isn't the tax problem you
allude to, on the investment income earmarked for policy holders.
Essentially (I think) they're taxed on income above what's
necessary to cover policies, based on the number crunching by the
actuaries. Or something like that.
Rock:
0) A single 30-year term policy will be used, annual
premium $485. The ages modeled are 42-99, with the
insurance dropped at age 71.
Huge variation there. Might be at 41, might be never. Maybe you
find out the average age that people drop their policies. I have
no basis for picking a specific age because it seems to depend on
the individual, but maybe you'll find a stat like "80% of people
drop their life insurance by XX" and you can say on your page
that this is your assumption.
Rock:
2) At age 70.5, principal and earnings have to start
coming out of the IRA.
Why - MRD? Variable here - if Roth, no MRD, if tax law changes -
who knows? If not MRD - realize that a lot of retirees are
actually net savers, and scale down spending a lot in the early
years.
Rock:
3) The investment will be transferred to a tax-free
municipal bond fund, spread evenly over a period of 20
years (age 71 to 90).
4) The muni fund will be given a 5.9% annualized return.
Below you cite a 15% tax rate, which means munis wouldn't be
appropriate, unless the spread between munis and taxable bonds
was low. Why not just keep ticking along at the same taxable
return as before, that way you only have one assumption to adjust
in the future?
5) Transferred gross earnings will be subject to ordinary
income tax at a 15% rate. (Only the money actually
transferred in a given year is taxed.) What the model
will actually do is not tax the transfer for the first
several years, then tax for the remainder of the 20
years. This is to avoid taxing the investment basis.
(If VBIIX had been in a 401k, I believe the basis would
be $0, hence it would be taxed for all 20 years.)
State taxes? (9.3% marginal in CA)
6) Once in the muni fund, the investment becomes tax-free,
not merely tax deferred.
Minor point, but that requires limited bond trading, no AMT
problems, and continued treatment under the tax code.
-Tad
Rock
from TTRoberts (TR), Ed Zellers (EZ), and Tad Borek (TB). Thank you
all very much (including any future posters).
Taxes
-----
I guess its universal. Everyone (including Beliavsky yesterday) is
uncomfortable with the model trying to account for internal &
invisible taxes paid by the insurance company on the policy.
So was I. In retrospect, bringing it up was a rationalization. Once
the BTID model began using a regular IRA rather than a Roth, I was
very uncomfortable with direct taxation of the BTID but not the policy
model.
The primary reason for abandoning the Roth was fairness if proceeds
are withdrawn while living. Gains on the policy would be taxed, but
gains on the BTID would not be. The regular IRA brought in an almost
equivalent problem; now IRA funds couldn't just sit until age 99.
They had to start coming out, creating a visible taxable event.
The same taxable event will occur if the funds are withdrawn from the
policy, but this is not visible in the curves displaying "pure
insurance". A loan doesn't escape gain loss -- it loses via annual
interest charges. The site needs a new page on using "living
benefits". Should someone withdraw money while living, both the BTID
and policy models experience equivalent taxation.
Going back to the Roth seems to remove even the possibility of tax
equivalence. I'll mention it as an option, however.
> (TB) Why - MRD?
Yes. The spreadsheet shows more total gain if I start with a high
quality bond fund than a tax-free muni. But eventually the rules for
minimum required distribution say the money has to start coming out.
> (TB) Why not just keep ticking along at the same
> taxable return as before, that way you only have one
> assumption to adjust in the future?
Less total taxes are paid (thru age 99) if MRD goes to tax free fund
than keeping money in taxable bond fund. If same 15% rate is assumed,
this reduces the assumed VBIIX rate of 6.75% down to 5.74%. I thought
5.9% in the tax-free fund was "fairer". I realize that a lot will
change in 40 years, and these assumptions are probably an exercise in
futility. My spreadsheet doesn't care, though. It said "feed me",
and I fed it.
> (TR) Only the amount coming out of the IRA will be
> income to heirs. The other tax-free muni-bond fund
> will not and it will also receive a step up in basis
> for the heirs.
Great! Transferring from VBIIX to muni-fund helps fairness much
better than I thought. If the heirs receiving the muni-bond fund are
not taxed on it as "income", then the insurance and the BTID strategy
achieve "death equivalence", right? (Presuming one dies conveniently
after the IRA is fully transferred to muni.)
> (EZ) So I do tend to correct anyone, in any type of
> investment, who uses the term "tax free" inappropriately.
> Tax free needs to be limited to truly "never to be
> income taxed" types of income and cash flow, such as the
> death benefit from a life insurance policy, municipal
> bond interest and qualified distributions from a Roth IRA.
I'll be careful!
> (TR) Hopefully, my explanation of the "premium tax"
> shows why there's really no correlation here. There's
> no death benefit in an IRA to insure . . . so why
> would there be such a tax on money going into any type
> of IRA??? ;-)
It did help, thanks. Why states and nations tax what they tax is a
question for another thread. :)
> (TB) State taxes? (9.3% marginal in CA)
I'll use Florida assumptions, thank you. No state income tax. :) The
site should mention that this could be an issue, though.
Roth
----
> (TR) Hmmmm??? Why not do a Roth too?
[Rock screams softly.] The spreadsheet already contains 5 models:
1) base policy -- 12 years of o-o-p premium payments
2) base with extra payments -- premiums for 19 years
3) base with OPP payments -- overfunded for 14 years
4) min T+I -- BTID with o-o-p cash of strategy 1
5) max T+I -- BTID with o-o-p cash of strategy 3
(Last year I didn't know BTID was the common acronym. Thus "T+I" for
Term+Invest. o-o-p == out-of-pocket)
Modeling both a regular IRA and a Roth would add two more. I could
even model a 401(k). Or the money going immediately into a tax free
bond fund. [less softly this time...]
Since I am actually following strategy #3, this is the primary
historical record The Visible Policy provides. I need to model
strategy #1 because NYLIC doesn't reveal its "dividend scale". #1 is
decomposed so I have sane dividend rates to use in #3. The other
strategies derive from my own curiosity.
Term Policy
-----------
> (TR) Using an annual level term premium is very
> often used to try to keep things as simple as
> possible. However it's not a good way for a
> comparison as the COI(cost of insurance) within
> a WL contract is NOT level. It's not that hard
> to get numbers that might be more realistic where
> the COI is increasing in your model for the BTID
> side of your Franklin "T".
(I lost you on the "Franklin 'T'" allusion.)
One of the main changes between my original model and the current one
is the type of term insurance. It had been three consecutive ten-year
term policies, but virtually everyone who commented on that part of
the model said it was risky and expensive. Basically they said, "if
you know you are going to model thirty years of insurance, use a
30-year term policy."
"Realism in COI" is subjective, IMO. If Death Benefit is a primary
objective, a 30-year term policy should be reasonable. I don't think
I have seen a BTID advocate who thinks the term policy should be kept
through "age of mortality". So dropping the term after 30 years
allows the investment portion to build up a nest egg which can still
provide "insurance" should death occur.
> (TR) If the insurance is going to be dropped at
> age 71, then you'll need to do the same for the
> Whole Life contract. And if one is going to do
> this with the Whole Life contract, then BTID wins
> as a WL contract is supposed to be kept for one's
> entire lifetime and works best when done so.
I disagree. BTID seems to be a philosophy as much as a strategy with
many people. If I kept term insurance in place, I don't think any
BTID advocates would consider my model fair.
As far as which stategy "wins", take a look at these IWR charts:
http://dbatitan.home.att.net/vp/vl07.html
The "min T+I" strategy wins over "Base Policy" in cash value. Base
Policy does have a minor lead after it stops paying premiums. But
when min T+I stops paying its premiums, it pulls decisively ahead.
(This part of the curve is exactly what you describe.) It usually
wins in Death Benefit as well, except for about 20 years after the
term insurance is dropped. For those 20 years, "Base Policy" wins in
Death Benefit, but T+I eventually catches up even without the help of
a term policy.
It is a different story for the "max T+I" strategy. It has a huge
headstart, and for 21 years its cash value exceeds that of the OPP
strategy. After that, it drifts to the other side of the OPP curve
and they continue kinda-sorta in parallel. Dropping the term policy
(and $485/year load) is a hardly noticeable event at age 72.
For Death Benefit, of course, the loss of $100,000 in value is very
noticeable. But the overfunding of the whole life policy with OPP
payments has kept its death benefit ahead of "max T+I" anyway.
> (TB) Huge variation there. Might be at 41,
> might be never. Maybe you find out the average
> age that people drop their policies. I have no
> basis for picking a specific age because it
> seems to depend on the individual, but maybe
> you'll find a stat like "80% of people drop
> their life insurance by XX" and you can say on
> your page that this is your assumption.
The 30 years is almost arbitrary. It is long enough, though, that the
invested dollars still provide significant death benefit should the
"insured" expire after the term.
Loans
-----
> (TR) But note: Not only will the loan be
> generating interest charges, the amount that
> is loaned will also be earning interest . . .
> but at a different rate.
What you say is true for some other companies. NYLIC policies use
"non-direct recognition" regarding loans. You describe "direct
recognition". NYLIC keeps the dividend crediting rate constant
whether or not the policyholder takes a loan. Instead, it allows the
interest rate charged on the loan to vary. Your primary point about a
"spread" between the interest one pays on the loan and the dividends
earned by the loaned principle is still valid. The net loan cost is
quite low.
Investment
----------
> (TB) Choice of fund - you'd hope that in the
> BTID you'd pick something more aggressive, and
> more tax-advantaged, than a bond fund in an IRA
> that's invested for as many years as you're
> suggesting. Maybe you need to go with this, but
> if someone wants financial security many years
> from now you'd think the topic of stocks (and the
> inflation problems of bonds) would come up, ya?
Beliavsky brought up the same point, worded somewhat in the reverse.
He said that, by its nature, a BTID strategy is much closer to a VUL
policy than a par. whole life policy. Thus he suggested that I
compare BTID::VUL rather than pWL::BTID.
Whether worded backwards or forwards, it is probably the fundamental
question. My answer goes back to the reason I chose a par. WL policy
in the first place. I wanted something conservative and had a
guaranteed structure. I have a 401(k), funded with 15% of my
paycheck. I have a Roth IRA, funded to the legal limits. The
insurance policy is not the only part of my "portfolio", but it is
intentionally the most conservative.
So, in comparing my insurance policy, bought with my objectives in
mind, I believe the fair comparison is with a BTID strategy following
the same conservative assumptions. If dependent on "BTID" for my
entire retirement savings, I probably would pursue a more aggressive
course. But by the same reasoning, a cash value life insurance policy
bought as my entire retirement "savings" would probably pursue the
more aggressive VUL course.
As I told B., the spreadsheet will be downloadable, and you can watch
BTID beat the pants off my whole life policy. Just plug in 9% return
in the rate column. I'm not sure what kind of "comparison" that would
be, however.
I would love for someone to author a "Visible Policy" site for a VUL
policy. And another site for a Universal Life policy. Unfortunately,
I am not competent to author them.
General
-------
> (TB) I thought you said "Parisian," so I didn't reply.
Nah, I wouldn't have said that. It is my goal to get feedback, not
insult anyone. [whistles innocently to self]
> (TB) No seriously, the BBAG page has exceeded
> my MIFP time budget ...
I hope you mean the IWR page. The BBAG page still describes the old
model. I wanted you to exceed your time budget on the _new_ model.
:)
Does anyone want to make any comments about the results shown by IWR?
-- Rich
--- The Visible Policy, Inflation Wave Ratio
---- http://dbatitan.home.att.net/vp/vl07.html
Nathaniel Hummel
amazed to peruse your visible policy site. On 12/23/68 I walked in
the back door (hired help entrance) of New York Life's Pasadena, CA
office on my first official day of employment as a new, novice agent.
I had studied the equivalent of about 3 months or so of "pre-training"
material, so I had a little edge up on a toadstool, but that was about
all. As a complete aside, I believe the current Nylic building was
built on the site of the original Madison Square Gardens. I think the
ghosts of former prize fighters may have haunted the executive offices
of Nylic, and that may explain a lot wrt to the "punch drunk" behavior
for which they have been, at various times, accused of. Come to think
of it, I believe any such accusations may have been made by
disgruntled agents after a few beers too many.
In 1971 I started my CLU studies. The first class was what the
old-timers used to call "rate-making." It occurs to me that this
course would be right down your alley, wrt your "visible policy"
treatise. I think by the time I took the course it had been broken up
from a school year to 2 semesters. One area actually tested the
ability of agents, who are by nature not know to necessarily be adroit
students, to hang on to their sanity as they tried to make sense of
the mathematics of whole life insurance. Some of the students just
decided that they would have to make up for the zero they would get in
this area of the testing by throwing themselves into such arcane
subjects as life insurance law and the like. For those few of us who
actually made sense of the process of whole life rates and the
associated cash values that grew from this peculiar ritual of stuffing
money into an apocryphal "black box", we kind of thought the
experience was like when you first wake up in the morning and you
swear there's some compelling logic to an intense dream you just
had... but now it has become elusive. By the time the test was over
with, so was the memory of how it ever made sense. I only wish I had
saved the rather thick book that dealt with this black art. I imagine
it might be helpful to you about now.
I'm not entirely sure why I brought all this up... maybe because I'm
trying to get sleepy so I can go to bed... and I think it worked.
Best,
Nathaniel Hummel, ChFC, CLU
Rock wrote:
...such a lot of stuff I wouldn't presume to know where to start to
address it all, so I won't. :)
Rock
> Rich, I check in, from time to time, on this forum/newsgroup and I was
> amazed to peruse your visible policy site.
Nathaniel,
I hope that you mean "amazed" in a good way. :)
> ... For those few of us who
> actually made sense of the process of whole life rates and the
> associated cash values that grew from this peculiar ritual of stuffing
> money into an apocryphal "black box", we kind of thought the
> experience was like when you first wake up in the morning and you
> swear there's some compelling logic to an intense dream you just
> had... but now it has become elusive. By the time the test was over
> with, so was the memory of how it ever made sense. I only wish I had
> saved the rather thick book that dealt with this black art. I imagine
> it might be helpful to you about now.
"About now" you are right. Up to now my goal has been to reverse
engineer the policy with my training and experience as a programmer.
I thought it might be useful to make an extensive outside examination,
instead of repeating what others had written about what they had been
taught. Now that the site is close to being "done", sanity checks are
definately in order!
> I'm not entirely sure why I brought all this up... maybe because I'm
> trying to get sleepy so I can go to bed... and I think it worked.
Great idea -- The Visible Policy as a non-prescription sleep aid! Now
if the FDA doesn't have a hissy fit, things oughta be cool. :)
-- Rich
--- The Visible Policy
---- "If it can't put you to sleep, nothing can."
----- http://dbatitan.home.att.net/vp/
Brent D. Gardner ChFC
>"About now" you are right. Up to now my goal has been to reverse
>engineer the policy with my training and experience as a programmer.
>I thought it might be useful to make an extensive outside examination,
>instead of repeating what others had written about what they had been
>taught. Now that the site is close to being "done", sanity checks are
>definately in order!
Perhaps you should contact the professors at The American College? They might
even be able to find Nathaniel's old text book in their library, and I
understand they have an interlibrary loan process so that you can borrow it
locally (you might have to get a local TAC student to borrow it for you -- I
don't know if they lend to nonstudents).
TAC maintains an extensive library of old, and out of print, insurance texts.
One day, I will visit...