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If there’s anything that will catch the eye of our elected officials in Washington, DC, it’s an advertisement like this article’s heading. There’s more than a few pundits predicting the government will one day attempt to confiscate retirement plans to help lessen our national debt.

The “100% Tax-Free Retirement” has also been labeled “Secret 770 Account”, “President’s Plan” (referring to prior U.S. Presidents), “Magic Contract”, and “Invisible Retirement Account”. These terms have been promoted over the past several years in the Palm Beach Newsletter. The newsletter goes on to say your profits don’t have to be reported to Uncle Sam and there is a guaranteed growth of 4 percent yearly. It’s not real estate, annuity, or stock and bond certificate either! Your broker won’t tell you about it because these contracts are not even traded on the Exchange.

This is a great deal, so I’ll just dash over to Newton Federal and get a home equity line so I can buy one of these products! Before you do that, have you figured out what it is first? The term 770 account is your tip-off because that refers to the section of the Revenue Code that addresses cash value life insurance. The specific life insurance product they are referencing to is a participating or dividend paying life insurance policy.

Now before you go call Clark Howard to report a scam alert, several of the statements in this newsletter are true:

– Most U.S. presidents have owned cash value life insurance.

– Mutual life insurance companies theoretically are owned by the policyholders as there is no stock traded on the Exchanges.

– The buildup of the guaranteed cash value along with any dividends payable does exceed 4 percent and in many cases more. The payment of a dividend from an insurer is considered a return of a premium overcharge, hence the tax-free treatment.

There are some potential “gotchas” in using one of these plans for retirement income:

– Traditional whole life insurance is a long term program that will need 20-plus years to work efficiently. I’m 67, so I’m not much of a prospect.

– You will generate retirement funds through borrowing. Policy loan interest is no longer deductible so that needs to be considered.

– Depending on contract design, borrowing or surrender of dividends ……can reduce the rate paid on accumulations.
One major consideration with these plans is the premium limitation. Overfunding of life insurance policies was very popular in the 1970s and 1980s, but that changed with the passage of the 1988 Technical and Miscellaneous Revenue Act (TAMRA). This created a funding limit for any life policy issued after TAMRA was passed. Any excess funding over that limit will automatically make the contract a Modified Endowment Contract (MEC). This classification is irrevocable so a withdrawal is reportable income prior to the non-taxable return of principal.

The second consideration is over-borrowing. When a life policy’s cash value is exhausted through borrowing or premium loans, you may have a taxable event through cancellation of the loan or “Forgiveness of Debt”. If the amount of loan cancelled plus any remaining cash value exceeds premiums paid, you will have a taxable event. I have seen some big ones over the years.

In spite of my reservations about participating life insurance as a fantastic retirement funding vehicle, there are some areas where traditional life insurance can have some real appeal.

Permanent life insurance as an educational funding vehicle can be attractive. A policy issued on a child and owned by the parents can build up a respectable amount of cash without a requirement of having to liquidate the account by a certain age.

Single premium gifts of life insurance to a grandchild will, over time, build up some very significant values. This one is the classic case of Einstein’s comment of “Compound interest is the Eighth Wonder of the World”.

Sources: for the various names used by Palm Beach Letter

Mike Lassiter is a Chartered Life Underwriter and Chartered Financial Consultant. He is a Licensed Insurance Counselor and a Registered Investment Advisor. He can be reached locally at 770-786-2781.