In today's video
we are going to answer the question
do I get more cash value
by lowering my death benefit?
This question was raised by an individual
recently who's considering
a whole life insurance policy
for high cash value
but in reviewing the numbers
the death benefit reduction
really jumped out at him.
He said why is the death benefit
reducing there?
When do I get it back?
What does it look like
if I keep my death benefit at that number?
So we're going to use that case study
or use the question the individual asked
as the foundation
for answering the question today.
So the question again is
do you get more cash value
by lowering your death benefit?
The specific case study is as follows
we had an individual age 49
he's interested in funding a policy
for a short period of time
$100,000 per year for 5 years
that gets a total of $500,000 into the policy.
His goal maximize the cash value
cash value benefits here
the core benefits of being safe
liquid and tax-free.
This tax-free piece what do we always say?
Tax-free if we do not trigger a taxable event
the most common being
a modified endowment contract or a MEC
keep that in mind because that's very important
when answering this question.
So option to maximize the cash value
is reduce the death benefit
reducing the death benefit
reduces expenses in the policy
which results in more cash value
this is especially true
when one is in a situation
where they do not want to make payments
for a long period of time
so if I have a lump sum of money
I want to get it into a policy quickly
when I'm not making
any more premium payments
I'm not adding anything else into the policy
what I want to make sure of
is that the cash value growth is maximized
and there are levers I can pull on a policy
in order to reduce the death benefit
or minimize it which gives me more cash value
that's the name of the game
however there are IRS rules to be aware of.
So I'm going to go through these rather quickly
here's what we've got so the IRS rule
on cash value life insurance
in order to keep the third core benefit
the tax-free piece are as follows
with a whole life insurance policy
we have the modified endowment contract
if a life insurance policy becomes classified
as a modified endowment contract or a MEC
what happens is that the cash value
can be taxable when you access it
specifically what happens
is if your policy becomes a MEC
the cash value still grows tax-deferred
the death benefit is still paid out
income tax-free
however back to the cash value
if you ever decide to access the cash value
either through a withdrawal
or through a loan
what happens is that the gains will be taxable
as ordinary income to you
and if you're under the age of 59 and a half
you could have
a potential 10% penalty tax as well
in short we don't want that
modified endowment contract to occur.
So here's how we prevent it
every policy has what is called a MEC test
another name for this is our 7-Pay test
sometimes it's called a 7-Pay premium
or 7 premium test
but what that 7 has to do with
is the 1st 7 years of a life insurance policy.
Now we've got our MEC limit
a MEC limit is exactly what it sounds like
it is a limit that determines
the maximum dollar amount
you can pay into a policy
and still have the IRS
view your life insurance policy as life insurance
and be able to access that cash value tax-free.
If we go over this limit what happens?
Your policy becomes a MEC
then we've got to deal with the MEC rules
and taxes it's no fun.
So here's the thing about the MEC limit
this is the fun part
we can set it wherever we want
when we're setting that MEC limit
what you'll find it has a direct relationship to
is an individual's age
and total death benefit on a policy
there are other factors that impact the MEC limit
gender has a role
also the guaranteed rate on a product
will have a significant impact
on the initial MEC limit
however the total death benefit and age
those are the two most important things
so if this individual
wants to pay in $100,000 per year
what we're going to do
based on his age of 49
is solve for the minimum death benefit needed
so he can pay in $100,000 per year
because his goal is to maximize cash value.
Do you follow?
Pretty neat, right?
So here's another item to be aware of
is if the death benefit
is lowered during the 1st 7 years
the MEC limit will be lowered
so for example
he pays in $100,000 per year
for how many years?
For 5 years
when he's done paying into it
can he reduce the death benefit in year 6
in order to reduce expenses
when he's not paying anything in?
No, because that will trip the MEC limit here
so let's go through this in detail
and then we're going to look at the illustration
so we can see everything
here's what we've got
49-year-old individual funding $100,000 per year
that's the maximum he'll pay in
in the scenarios we're looking at
so the MEC limit we need is $100,000
at his age we need a death benefit
of $1,600,000
you'll actually see
it's just a hair above 1,600,000
it's $1,605,000
$1,600,000 gave him
a $99,000 MEC limit and change
my point is when you see the exact illustration
there'll be an additional $500,000
in life insurance to prevent the MEC.
Now keep this peace in mind
we cannot reduce the death benefit
until the 8th year
because if we reduce the death benefit
during the 1st 7 years
the MEC limit will be reduced
and if the MEC limit falls below
what any of our payments were
in the 1st 7 years
if it falls below $100,000
the policy will become a MEC
so what we're going to do here
is reduce the death benefit in the 8th year
so what this will do is maximize the cash value
without triggering a MEC
so that's exactly what we looked at
however a question popped up
he saw the death benefit drop
and he said okay wait a minute
what if I don't want that death benefit reduced?
What if I want to keep it the same?
Man if something happens to me
I do like seeing this $1,600,000 paid to my wife
what happens
if I move forward with this strategy
this exact policy
funding at $100,000 per year for 5 years
but I don't reduce the death benefit?
What if I keep it the same?
well here's the way I would ask the question
or ask the question for him
or someone that I'm helping
if I'm working with an agent
if I'm serving call it a third-party advisor
is specifically what's the cost
not that you're going
to add more money to the policy
but what does it cost you
in cash value performance
and death benefit performance long term?
Because what I'll add
is when we reduce the death benefit in a policy
to maximize cash value
that's exactly what we're doing
that's what the individual wants to do
they want to get
as much cash value growth as possible
so that will result
in less death benefit immediately
however
the option with the most cash value long term
will have the highest death benefit long term
in most scenarios
and the reason why
is because when I hit age 100
in a life insurance policy
what happens to the cash value
and death benefit?
They become equal
now with some products
that doesn't happen until age 121
but most you'll see is age 100
and my point there
is when one hits their 80s and 90s
nearing mortality when we might die
if I've got the most cash value with that option
where I've reduced the death benefit initially
to juice my cash value
my death benefit will be higher
than what it would have been
if I did not reduce it
so we're going to look at some visuals
on that point so let's have some fun.
What we will start with
is what most individuals we work with
decide to do
so up here in green
you see reduced death benefit
maximize cash value
$100,000 per year funded for 5 years
the policy is maximized for cash value
the 1st year $100,000 goes in
it's $83,500
so just about close to 84% in the 1st year
there's your death benefit of $1,605,000
which kind of drives me nuts with my OCD
but why it's there
is because that gives him a MEC limit
of $100,000
if we go down to $1,600,000
we don't have that MEC limit of $100,000
it's $99,000 and change.
So there's the funding
year 5 is our breakeven point
we've paid in $500,000 we've got $502,000
now year 6 and 7
we won't see it on the Excel workbook
you'll see it in the detailed illustration
there's still a premium due
we're not paying it
the policy is paying the premium for us.
What happens with your death benefit?
It doesn't change
we've got a term Rider attached as well
so the policy is paying for itself in this scenario
that in year 8 we eliminate the premium
the option we used here
you'll see this on your illustration
is a reduced paid-up
which gets rid of the term Rider as well
but we eliminate the premium
and that results in the strongest
cash value growth moving forward.
Alright sweet
and eventually
what happens with that death benefit?
Well first initially
we see it dropped to under $1,200,000
that's what caused him to pause
so if this is you and you said okay
cash value is my goal however
the death benefit's important
I don't know that I'm comfortable with that
what other options do I have with this policy?
Okay so this is why the purpose of this video
and we're going to look at a solution next
but what I would also highlight is the fact
that it does recover over time
this is based
on the present dividend interest rate
so things will change over time
but here it recovers right at age 70.
Okay keep the death benefit at $1,660,000
this is the exact same policy
and you will notice through policy year 7
everything's identical
your cash value and death benefit figures
so if we elect to reduce the death benefits
or keep it the same
it is not something that we declare upfront
when we start the policy
meaning this individual can start his policy
and then he can decide when year 8 comes
if he wants to reduce it
or if he wants to keep it the same
the same is true of the funding
that can adjust to over time
so for peace of mind
you don't have to feel like you have to choose
exactly what you're going to do
when starting a policy
because we all know life happens
things change
I think I'm going to commit to plan A
but something happens where all of a sudden
plan A became plan C
you know what I mean so let's continue on.
So what we've got here
is the death benefit remaining at $1,605,000
and eventually this increases too
what happens
is we've got a one-year term Rider here
and it is gradually expiring
as the whole life-death benefit increases
my point is eventually the term burns out
and you'll see
your whole life death benefit increase.
What was the question that I would ask
if I'm sitting on your side of the table
or his side of the table
I'd say what does it cost him or the client
if he keeps the death benefit at $1,605,000?
That is what I would want to know
when I say what does it cost him
I don't mean him paying more money
because what he wants to do
is get $500,000 in over 5 years
he wants to use it for real estate
the cost is what's it going to cost him
in cash value performance
and death benefit performance over time?
So this will represent how much more
or how much less
we have in cash value and death benefit
with this option highlighted in gold
compared to the option highlighted in green
so for the 1st 7 years identical
because it's the same policy
In year 8 what do we see here?
$2,400 less
this represents the fact
that by keeping the death benefit
not cutting the term Rider
not getting rid of the base premium
but by keeping it high
we've got $2,400 less in cash value.
If we look at age 65
$44,000 less in cash value.
What's the death benefit though?
I gotta look at that to be fair
several hundred thousand dollars
the 1st year you've got
$400,000 and change more
by age 65 $171,000 and change more
so if he passes at age 65
and he decided to maintain the death benefit
he would have had $44,000 less to work with
at that point in time but if he dies
there's another $170,000 and change
that's paid to his beneficiary
that's income tax-free as well is paid out
so that's what we've got to consider here
however as time passes what happens?
Remember what we mentioned
the policy that has
the highest cash value long term
will also have the highest
death benefit long term
so there we go it's really by age 70 here
that we see the cash value
maximization strategy gives me more long term
meaning option A has more money
and there's other things you can do here too
some people say hey
could I just get a term policy
say it's a level 10-year term for $400,000
or something like that just to bridge that gap
the answer is yes you absolutely could do that.
Another thing that popped up here
and we'll wrap up with this
is what if I keep paying
because yeah the plan was to fund for 5 years
but if I wanted to add more money can I?
The answer is yes
he could throw in another
$100,000 in year 6 if he wanted to
he could pay $25,000 some years
the policy is very flexible
so he can adjust what he pays in
but here we're going to look at funding
just the minimum here
but also maintaining the death benefit
so this is not really a fair example
to compare to the 1st two
with respect to the cash value growth
because we're pumping more money in
but it is nice to see
from a consumer's perspective to say hey
if I don't have an issue paying another 10,000
or whatever dollar amount he wants to pay in
what's the impact on my policy?
Well we see by year 6 things are moving
by paying $10,000 I get the $10,000 back
because then the $10,000 puts me to $512,000
plus another $22,000 on top of it I'm at $534,000
so I'm not seeing that go out the door
just to costs and expenses
it's building equity for me so I have access to it
there's the cash value
just about at $1,000,000
look at the death benefit
it was able to keep it at $1,605,000
and it increased quite quickly too
now you'll notice a little dip there
so if he doesn't want to do this
he doesn't have to
but in this option we did the same thing
that we did in this option
meaning when he was done funding
we did reduce the death benefit
as low as we could push it at that point in time
to maximize cash value growth
at this stage however
he's above the original $1,600,000
so that's why we did that
because he has what he wants
so we might as well
maximize everything moving forward.
So the answer to the question
do I get more cash value
by lowering my death benefit?
Yes, however if you hesitate
upon seeing that death benefit drop
what I would look at is a comparison
specifically what we saw there
what does it look like if we
maximize cash value
when we're no longer paying
by reducing the expenses
eliminating the premium
compared to keeping the premium there
keeping the term Rider attached
and ask specifically
what does it cost me in performance?
What's the difference
in cash value and death benefit
short-term and long-term?
That's what I would look at
to really help me make a decision
and the nice thing about this is (1)
you do not have to choose upfront
these are adjustments you can make to a policy
as time passes
but (2) it can be any time after the 7th year
so we Illustrated there
that reduction in policy year 8
say it's year 8 you don't know
well it can be a year-to-year decision
you can say you know what
let's keep the death benefit high
years 8, 9, and 10
and then by year 11 you know what
I don't need it let's reduce it
maybe we only partially reduce it
we can cut the term insurance
keep the premium there
we don't have to eliminate that
through that reduced paid-up option
I'm getting technical here
my point is we've got options there
and when someone's trying to figure out
what lever they want to pull
what we want to make sure of
is that we provide the available options there
and really let you know if you go this route
there's no turning back
however here's an option you can
partially exercise
and here's your options available afterwards
this way we can use the policy
really how we want to right now
without hurting us long-term.
So I hope you enjoyed this one
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let us know if you have any questions at all
and as always I hope this helps.
Thanks so much.
Hey guys Steve Parisi here
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