I was told that the cash value is not yours. What are the pro's and con's about a VUL.
Total Comments: 12
Posted: Tue Aug 05, 2008 03:51 pm Post Subject:
Here are the risks for Variable Universal Life:
* Cost of Insurance - The cost of insurance for VULs is generally based on term rates.
* Cash Outlay - The cash needed to effectively use a VUL is generally much higher than other types of insurance policies. If a policy does not have the right amount of funding, it may lapse.
* Investment Risk - Because the sub accounts in the VUL may be invested in stocks and bonds, the insured now takes on the investment risk rather than the insurance company.
* Complexity - The VUL is a complex product, and can easily be used (or sold) inappropriately because of this. Proper funding, investing, and planning are usually required in order for the VUL to work as expected.
Variable universal life (VUL) is yet another form of cash value life insurance. Like any other life insurance policy, an amount of money called the face value (also called the death benefit) is paid out when the insured dies. As is with a whole life plan, the VUL policy builds cash value that grows tax-deferred over time, and allows you the option to borrow against it. Unlike term, traditional whole-life, or regular universal life insurance, VUL policies allow the policy holder to choose how the premiums are invested, and these choices are usually laid out in front of you. This means that the policy's cash value as well as the death benefit can, and certainly do, fluctuate with the performance of the investments that the policy holder chose.
Where does the name come from? To take the second part first, the "universal" component refers to the fact the premium is not a "set in stone" amount as would be true with traditional whole life, but rather can be varied within a range. As for the first part of the name, the "variable" portion refers to the fact that the policy owner can direct the investments him/herself from a pool of options given in the policy and thus the cash value will vary. So, for instance, you can decide the cash value should be invested in various types of equities (while it can be invested in non-equities, most interest in VUL policies comes from those that want to use equities). Obviously, you bear the risk of performance in the policy, and remember we have to keep enough available to fund the expenses each year. So, bad performance could require an increase in premiums to keep the policy in force. On the other hand, if you get a better return on your investment (your cash value increases) you win.
If a VUL policy holder was fortunate enough to choose investments that yield returns anything like what the NASDAQ saw in 1999, the policy's cash value could grow quite large indeed. The cash value component of the policy may be in addition to the death benefit should you die (you get face insurance value *plus* the benefit) *OR* serve to effectively reduce the death benefit (you get the face value, which means the cash value effectively goes to subsidize the death benefit). It all depends on the policy.
A useful way to think about VUL is to think of buying pure term insurance and investing money in a mutual fund at the same time. This is essentially what the insurance company that sells you a VUL is doing for you. However, unlike your usual mutual fund that may pass on capital gains and other income-tax obligations annually, the investments in a VUL grow on a tax-deferred basis. Uncle Sam may get a taste eventually (if the policy is cashed in or ceases to remain in force), but not while the funds are growing and the policy is maintained.
We can address the insurance component of a VUL and about the investment component. The insurance component obviously provides the death benefit in the early years of the policy if needed. The investment component serves as "bank" of sorts for the amounts left over after charges are applied against the premium paid, namely charges for mortality (to fund the payouts for those that die with amounts paid beyond the cash values), administrative fees and agent commissions. How this amount is invested is the principal difference between a VUL and other insurance policies.
If you own a VUL policy, you can borrow against the cash value build-up inside the policy. Because monies borrowed from a VUL policy that is maintained through the insured's life are technically borrowed against the death benefit, they work out tax free. This means a VUL owner can borrow money during retirement against the cash value of the policy and never pay tax on that money. It sounds almost too good to be true, but it's true.
A policy holder who elects to borrow against the death benefit must be extremely careful. A policy collapses when the cash value plus any continuing payments aren't enough to keep the basic insurance in force, and that causes the previously tax-free loans to be viewed as taxable income. Too much borrowing can trigger a collapse. Here's how it can happen. As the insured ages, Cost of Insurance (COI) per thousand dollars of insurance rises. With a term policy, it's no big deal - the owner can just cancel or let it lapse without tax consequences, they just have no more life insurance policy. But with a cash value policy such as VUL there is the problem of distributions that the owner may take. Say on a policy with a cash value of $100,000 I start taking $10,000 per year withdrawals/loans. Say I keep doing this for 30 years, and then the variability of the market bites the investment and the cash value gets exhausted. I may have put say 50,000 into the policy - that's my cost basis, and I took that much out as withdrawals. But the other $250,000 is technically a loan against the death benefit, and I don't have to pay taxes on it - until there's suddenly no death benefit because there's no policy. So here's $250,000 I suddenly have to pay taxes on.
Once the policy is no longer in force, all the money borrowed suddenly counts as taxable income, and the policy holder either has taxable income with no cash to show for it, or a need to start paying premiums again. At the point of collapse, the owner could be (reasonably likely) destitute anyway, so there may be very little in the way of real consequences, but if there are still assets, like a home, other monies, etcetera, you see that there could be problems. Which is why cash value life insurance should be the *last* thing you take distributions from in most cases (The more tax-favored they are, the longer you put off distributions.) What all this means is that the cash surrender value of the VUL really isn't totally available at any point in time, since accessing it all will result in a tax liability. If you want to consider the real cash value, you need realistic projections of what can be safely borrowed from the policy.
This seems like a good time to mention one other aspect of taxes and life insurance, namely FIFO (first-in first-out) treatment. In other words, if a policy holder withdraws money from a cash-value life insurance policy, the withdrawal is assumed to come from contributions first, not earnings. Withdrawals that come from contributions aren't taxable (unless it's qualified money, which rarely happens). After the contributions are exhausted, then withdrawals are assumed to come from earnings.
Accurately computing the future value of a VUL policy borders on the impossible. Any single line projection of the VUL is, a) virtually certain to be wrong and b) without question overly simplistic. This is a rather complex beast that brings with it a wide range of potential outcomes. Remember that while we cannot predict the future, we know pretty much for sure that you won't get a nice even rate of return each year (though that's likely what all VUL illustrations will assume). The date when returns are earned can be far more important than the average return earned. To compare a VUL with other choices, you need to do a lot of "what ifs" including looking at the impacts of uneven returns, and understand all the items in the presentation that may vary (including your date of death (grin)).
While I hate to give "rules of thumb" in these areas, the closest I will come is to say that VUL normally makes the most sense when you can heavily fund the policy and are looking at a very long term for the funds to stay invested. The idea is to limit the "drag" on return from the insurance component, but get the tax shelter.
Another issue is that if you will have a taxable estate and helping to fund estate taxes is one of the needs you see for life insurance, the question of the ownership of the insurance policy will come into play. Note that this will complicate matters even further (and you probably already thought it was bad enough (grin)), because what you need to do to keep it out of your estate may conflict with other uses you had planned for the policy.
Note that there are "survivor VULs", insuring two lives, which are almost always sold for either estate planning or retirement plan purposes (or both). The cost of insurance is typically less than an annuity's M&E charges until the younger person is in their fifties.
A person who is considering purchasing a VUL policy needs to think clearly about his or her goals. Those goals will determine both whether a VUL is right tool and how it should be used. Potential goals include:
• Providing a pool of money that will only be tapped at my death, but will be used by my spouse.
• Providing a pool of money that will only be used at my death, but which we want to use to pay estate taxes.
• Providing a pool of money that I plan to borrow from in old age to live on, and which will, in the interim, provide a death benefit for my spouse.
Posted: Fri Apr 15, 2011 07:55 pm Post Subject: Tax Treatment of VUL if Cash Value Is Less than Premiums Pai
If one cashes in a Variable Life Insurance Contract and the cash value is less than the premiums paid, can the owner deduct the $3000 against earned income as they can with investments?
Posted: Sun Apr 17, 2011 01:18 am Post Subject:
Catherine . . .
When it comes to insurance products, such as Variable Life or Variable Universal Life, the whole discussion of CAPITAL GAINS disappears. That's one of the ways you would recognize that variable insurance products are NOT INVESTMENTS, they are insurance.
If you lost money on a mutual fund purchase, you could use the loss to offset up to 100% of your capital gains or up to $3000 of personal income in a tax year. If you lose money on an insurance contract, it's the same as if you flushed the money down the toilet.
The same rules apply to qualified retirement plans or annuities. If you have a loss, it is not deductible, and you take what you get. If you get nothing, oh well.
A similar rule applies to home ownership -- Uncle Sam might get you for capital gains on a "winning" sale, but he will not allow you to offset other capital gains or deduct a capital loss from personal income on the "losing" sale of your personal residence -- your home is not an investment, contrary to what banks and realtors tell you. Buy and sell homes as an "investor" and you can offset capital gains or deduct your capital losses with those losing sales.
So don't ever believe the agent (or insurance company) who wants you to believe your life insurance is an INVESTMENT. It never has been, and it never will be. Could it build cash value? Of course. But that is not CAPITAL GAIN -- and it cannot suffer a capital loss, the hallmark of a true investment.
Posted: Thu May 12, 2011 10:12 am Post Subject:
Max,
I must commend you on the amount of knowledge that you possess. The problem is that you seem to know about 90% of everything, yet seem to be confident that you know 100%.
In this case, you are making up your own definintions to prove your point. Who besides Max Herr would even attempt to define an investment by whether one can have a capital loss or not? That's a byproduct of our tax code and has nothing to do with whether something is defined as an investment.
By your logic, my purchase of Microsoft stock inside of my 401(k) is not an investment. A 529 plan is also not an investment. That's just plain old stupid. Don't confuse the tax code with what is and what is not an investment.
Is a prospectus needed? Is there a risk of loss? One can't answer "yes" to both of those and then claim something isn't an investment.
Variable life products are insurance. This doesn't mean that they are not investments.
Max, can you sell a variable product? The answer is "no". Why not? You have an insurance license. You don't have license to sell investments.
Do variable products require a prospectus? Yes. Why? They are considered investments. Does the prospectus call them an investment? Yes.
Max, I know that you'll respond that it is only the subaccounts that are investments, yet the subaccounts can't be purchased separately and although the money may be invested in a separate account, it's still part of one contract and a variable life policy is classified as a security. This is true even if all of the money is in the fixed account.
Go ahead and quote chapter and verse about insurance policies must be sold as insurance policies. That is true. However, if it is a variable policy, one can't gloss over the fact that is a security and must be sold as one also.
Max, in California, can a life insurance agent who is not a registered rep and can't charge for giving financial advice allowed to answer questions on securities in a public chatroom?
It is absolutely possible to have capital gains on an insurance product. One can claim a loss on an insurance contract.
Just so you don't make more of a fool of yourself, I'll give a quick example of both. Ex. Max has an insurance product with a basis of $50,000 and a cash surrender value of $70,000. He sells it for $80,000. He has a $10,000 capital gain. Ex. Max has a variable annuity with a basis of $100,000. He surrenders it for $50,000. Depending upon the rest of his tax situation, he may be able to take some or all of the loss. It isn't a capital loss.
I don't like variable universal life policies. Nobody should buy one because they want an investment. They should only be purchased because one believes that it is the best way to take care of their insurance needs. That doesn't stop them from being investments.....and insurance.
You'll be glad to know that this will be my only post. Best of luck to you.
Posted: Fri May 13, 2011 03:24 am Post Subject:
By your logic, my purchase of Microsoft stock inside of my 401(k) is not an investment. A 529 plan is also not an investment.
Actually, logic aside, that's correct.
And in a VUL you are "investing" (to allow use of that word) in subaccounts that are OWNED by the INSURANCE COMPANY -- you have no ownership of anything except an insurance contract that tells you how you can instruct the insurance company to deposit your money in your contract's cash accumulation. If it's not yours, you cannot deduct any losses -- more on that later. [And here's another clue, when you take a policy loan from any life insurance contract, you are borrowing the insurance company's other money, not yours, and not reducing the value of your cash accumulation. You pay interest to the insurance company, and it's all gravy to them. At least, in a 401(k) or 403(b), your holdings are liquidated to provide the funds you want to borrow, and the interest you pay on the loan is attributed to your account, not into the hands of the custodian.]
But, yes, when the VUL or retirement plan subaccounts are Management Investment Companies, they are regulated under the Investment Company Act of 1940, and their shares must be offered by prospectus through a FINRA member and/or registered rep.
No argument with that at all. To transact requires registration with FINRA as a general securities or variable investment products representative. Most states require a Series 63 registration in addition to the S-6 or S-7. When the product resides within an insurance contract, it also requires a life agent's license.
The subaccounts may include mutual fund-like creations, or perhaps even individual stocks, bonds, or ETFs. What's available in a VUL is determined by the INSURANCE COMPANY, not the insured. As an insured, you have no control over the selection of the subaccounts themselves, you only have the ability to allocate your cash value among the available choices.
Or it could go into a bank CD or money market account -- but I doubt anyone would call either of those an investment. Especially since they are not registered as securities.
The 401(k) plan, the 403(b) plan, the 529 "College SAVINGS" plan, like a VUL policy, is, itself, not an investment. It is merely a shelter from taxation (although the life insurance contract offers something none of the others do). That you may have internal choices that involve securities products does not change the essence of the PLAN/POLICY. And generally, you cannot hold life insurance as part of those plans, because that would be an attempt to change a taxable account into a non-taxable distribution at death. Perhaps that's what, apparently, is so confusing to people.
I guess, after all these years, I just haven't learned yet how much plainer I can make it so that insurance people can understand it. It's not a difficult concept, and my clients get it, but many in the industry have succumbed to all the marketing hype that the companies throw our way, and they cannot dissociate reality from hype.
I don't like variable universal life policies. Nobody should buy one because they want an investment. They should only be purchased because one believes that it is the best way to take care of their insurance needs.
Good for you! That, sir, is the essence of the debate. And you have it exactly 100% right -- up to that point. But VULs are not investments AND insurance, they are insurance with an investment component -- it both gives control over the rate of cash accumulation/decline AND all the risk of the contract collapsing to the contract owner. That's a significant difference that, apparently, few insurance people want to accept.
Ex. Max has an insurance product with a basis of $50,000 and a cash surrender value of $70,000. He sells it for $80,000. He has a $10,000 capital gain. Ex. Max has a variable annuity with a basis of $100,000. He surrenders it for $50,000. Depending upon the rest of his tax situation, he may be able to take some or all of the loss
Here your understanding of the tax code fails. NO INSURANCE PRODUCT IS, EVER HAS BEEN, OR EVER WILL BE, SUBJECT TO CAPITAL GAINS OR CAPITAL LOSSES. Period!
It is essentially the same thing with ownership of a personal residence. Your realtor, your banker/lender, and others will tell you your home is your biggest investment. It is NOT. For someone else's explanation of that concept, I recommend Robert Kiyosaki's book, "Cash Flow Quadrant" (and it would be a good idea to read his first book, "Rich Dad, Poor Dad" first).
Your mortgage is probably your biggest liability. Your home is a liability. Liabilities take money out of your pocket. When you sell your home, you can end up with a taxable gain, but you cannot deduct any capital loss if you sell it for less than your cost basis. The government regards your home almost the same way it regards life insurance for tax purposes, but it never regards your primary residence as an investment.
You can own other real estate, rent it to others to live in, and you can deduct 100% of your expenses to maintain that property, and you can sell it for a loss, and use the loss to offset other capital gains. You cannot do that with your primary residence.
The only way to obtain any credit for a loss on an insurance contract is on a person's final tax return after death. And, even then, it is not connected to the surrender of the policy, it is only connected to leaving principal with the insurance company because of a lifetime settlement option that didn't pan out due to early death. And it's still not considered a capital loss, it simply reduces taxable income. It FAILS the test of an investment.
Any other "loss" associated with an insurance product is a NON-DEDUCTIBLE loss. For the same reason that you cannot deduct the insurance premium/annuity purchase payment. The tax code does not permit it.
It is absolutely possible to have capital gains on an insurance product. One can claim a loss on an insurance contract.
Go ahead and try it. Then let us know how much you had to pay in penalties and interest for the miscalculation. Or quote the IRC section that you believe allows it (but you can't, because it does not exist).
Just so you don't make more of a fool of yourself,
Sorry to burst your bubble, but I have to turn this statement around on you.
Is an agent . . . allowed to answer questions on securities in a public chatroom?
Of course. Anyone can answer questions. Just can't give direct advice or effect securities transactions. As a former registered rep/principal (S-6, 63, 26), I am free to share my knowledge with anyone anywhere.
Posted: Fri May 13, 2011 02:22 pm Post Subject:
Max,
To know as much as you do and yet be so wrong about so many things is truly astounding.
NO INSURANCE PRODUCT IS, EVER HAS BEEN, OR EVER WILL BE, SUBJECT TO CAPITAL GAINS OR CAPITAL LOSSES. Period!
Are you sure that you want to be yelling this from the rooftops. It makes you look pretty silly to those of us who understand this better than your students.
Does your crystal ball know anything else about the future of our tax code? I don't know if your crystal ball is correct about the future. I can tell you that it's wrong about the present. Take a look at Revenue Ruling 2009-13. When a life insurance policy is sold for a gain, the gain above the cash surrender value of the policy is a capital gain. It's a shame that you will take the time to read this, but instead of admitting that you were wrong will try to twist things around.
Your example of borrowing is irrelevant. One can't ever borrow their own money. If one borrows from a variable policy, the first thing that happens is that money is moved from a variable sub account to a fixed account. The person does borrow the insurance company's money. This is not "all gravy" to the insurance company. If they weren't lending money to the insured at 6% (or whatever the rate happens to be), they would have that money to invest elsewhere. Policy loans, from the insurance companies perspective, are the same as any other investment that they make.
A 401(k) or 403(b) does not need to be an investment. One doesn't necessarily need to be securities licensed to set up these accounts. However, you are wrong about a 529 "College Savings" plan. 529 plans are "Municipal Fund Securities" and one must be registered to sell these plans.
For you to argue that Microsoft stock inside of a 401(k) plan is not an investment makes absolutely no sense. And, by the way, don't forget that it is possible to have CAPITAL GAINS (yes, I'm yelling) with money that comes from a 401(k) plan. As someone with just a Series 6, you would have never dealt with this situation. Feel free to yell some more if you'd like me to offer you proof that I'm correct.
Any other "loss" associated with an insurance product is a NON-DEDUCTIBLE loss.
Max, wow more yelling while you are wrong. Talk to some CPA's. A loss on a non-qualified annuity can be taken as a miscellaneous deduction.
Let me ask you about you saying that "anyone can answer questions." You may be able to do so as "former registered rep", but you probably couldn't do it if you were a "current registered rep". This is because it is considered advertising. As such, it would all need to be approved by your B/D and they most likely wouldn't allow it.
From a securities perspective, what you are doing here, would certainly be considered advertising. I would think that the same would be true from an insurance perspective, thus, the need to have you CA insurance number. Can you get in trouble here for your advertising since you are reaching people in places where you are not licensed?
You really do need to, at least, stop talking about variable products since you are both unlicensed and frequently wrong.
Posted: Sat May 14, 2011 12:03 am Post Subject:
Here we go again:
fjaksv,
You've made several great points here. I am not qualified as an Expert in the application of the tax code to life insurance matters. Because you seem fairly well versed in this area, maybe you could answer a question for me:
According to Revenue Ruling 2009-13, any profit [gains] received from the sale or surrender of life insurance is taxable as ordinary income. However, in your example you've classified these as "capital gains." Are the capital gains in your example taxed differently?
Posted: Sat May 14, 2011 01:19 am Post Subject:
Ex. Fred has a policy with a cost basis 50k and a csv of 60k. He sells it for 90k.
Taxes:
Ordinary income 10k
Capital gaims: 30l
Posted: Sat May 14, 2011 01:53 am Post Subject:
Interesting thread. From my experience, and I am not a CPA or giving tax advice, the gains on the sale of a life insurance policy are taxed as capital gains over cost basis like fjaksv stated. I would always recommend someone seek the advice of their CPA on the matter. It gets even more complicated with a term insurance policy that's converted and sold. I've heard from some sources that only the gain above the premiums paid for the term insurance are taxable and from other sources that as soon as the policy is converted, the cost basis resets to $0 and all gains are taxable since it is a separate policy being issued.
Posted: Tue Aug 05, 2008 03:51 pm Post Subject:
Here are the risks for Variable Universal Life:
* Cost of Insurance - The cost of insurance for VULs is generally based on term rates.
* Cash Outlay - The cash needed to effectively use a VUL is generally much higher than other types of insurance policies. If a policy does not have the right amount of funding, it may lapse.
* Investment Risk - Because the sub accounts in the VUL may be invested in stocks and bonds, the insured now takes on the investment risk rather than the insurance company.
* Complexity - The VUL is a complex product, and can easily be used (or sold) inappropriately because of this. Proper funding, investing, and planning are usually required in order for the VUL to work as expected.
Source: http://en.wikipedia.org/wiki/Variable_universal_life_insurance
Posted: Fri Sep 12, 2008 05:59 am Post Subject:
Variable Universal Life
Variable universal life (VUL) is yet another form of cash value life insurance. Like any other life insurance policy, an amount of money called the face value (also called the death benefit) is paid out when the insured dies. As is with a whole life plan, the VUL policy builds cash value that grows tax-deferred over time, and allows you the option to borrow against it. Unlike term, traditional whole-life, or regular universal life insurance, VUL policies allow the policy holder to choose how the premiums are invested, and these choices are usually laid out in front of you. This means that the policy's cash value as well as the death benefit can, and certainly do, fluctuate with the performance of the investments that the policy holder chose.
Where does the name come from? To take the second part first, the "universal" component refers to the fact the premium is not a "set in stone" amount as would be true with traditional whole life, but rather can be varied within a range. As for the first part of the name, the "variable" portion refers to the fact that the policy owner can direct the investments him/herself from a pool of options given in the policy and thus the cash value will vary. So, for instance, you can decide the cash value should be invested in various types of equities (while it can be invested in non-equities, most interest in VUL policies comes from those that want to use equities). Obviously, you bear the risk of performance in the policy, and remember we have to keep enough available to fund the expenses each year. So, bad performance could require an increase in premiums to keep the policy in force. On the other hand, if you get a better return on your investment (your cash value increases) you win.
If a VUL policy holder was fortunate enough to choose investments that yield returns anything like what the NASDAQ saw in 1999, the policy's cash value could grow quite large indeed. The cash value component of the policy may be in addition to the death benefit should you die (you get face insurance value *plus* the benefit) *OR* serve to effectively reduce the death benefit (you get the face value, which means the cash value effectively goes to subsidize the death benefit). It all depends on the policy.
A useful way to think about VUL is to think of buying pure term insurance and investing money in a mutual fund at the same time. This is essentially what the insurance company that sells you a VUL is doing for you. However, unlike your usual mutual fund that may pass on capital gains and other income-tax obligations annually, the investments in a VUL grow on a tax-deferred basis. Uncle Sam may get a taste eventually (if the policy is cashed in or ceases to remain in force), but not while the funds are growing and the policy is maintained.
We can address the insurance component of a VUL and about the investment component. The insurance component obviously provides the death benefit in the early years of the policy if needed. The investment component serves as "bank" of sorts for the amounts left over after charges are applied against the premium paid, namely charges for mortality (to fund the payouts for those that die with amounts paid beyond the cash values), administrative fees and agent commissions. How this amount is invested is the principal difference between a VUL and other insurance policies.
If you own a VUL policy, you can borrow against the cash value build-up inside the policy. Because monies borrowed from a VUL policy that is maintained through the insured's life are technically borrowed against the death benefit, they work out tax free. This means a VUL owner can borrow money during retirement against the cash value of the policy and never pay tax on that money. It sounds almost too good to be true, but it's true.
A policy holder who elects to borrow against the death benefit must be extremely careful. A policy collapses when the cash value plus any continuing payments aren't enough to keep the basic insurance in force, and that causes the previously tax-free loans to be viewed as taxable income. Too much borrowing can trigger a collapse. Here's how it can happen. As the insured ages, Cost of Insurance (COI) per thousand dollars of insurance rises. With a term policy, it's no big deal - the owner can just cancel or let it lapse without tax consequences, they just have no more life insurance policy. But with a cash value policy such as VUL there is the problem of distributions that the owner may take. Say on a policy with a cash value of $100,000 I start taking $10,000 per year withdrawals/loans. Say I keep doing this for 30 years, and then the variability of the market bites the investment and the cash value gets exhausted. I may have put say 50,000 into the policy - that's my cost basis, and I took that much out as withdrawals. But the other $250,000 is technically a loan against the death benefit, and I don't have to pay taxes on it - until there's suddenly no death benefit because there's no policy. So here's $250,000 I suddenly have to pay taxes on.
Once the policy is no longer in force, all the money borrowed suddenly counts as taxable income, and the policy holder either has taxable income with no cash to show for it, or a need to start paying premiums again. At the point of collapse, the owner could be (reasonably likely) destitute anyway, so there may be very little in the way of real consequences, but if there are still assets, like a home, other monies, etcetera, you see that there could be problems. Which is why cash value life insurance should be the *last* thing you take distributions from in most cases (The more tax-favored they are, the longer you put off distributions.) What all this means is that the cash surrender value of the VUL really isn't totally available at any point in time, since accessing it all will result in a tax liability. If you want to consider the real cash value, you need realistic projections of what can be safely borrowed from the policy.
This seems like a good time to mention one other aspect of taxes and life insurance, namely FIFO (first-in first-out) treatment. In other words, if a policy holder withdraws money from a cash-value life insurance policy, the withdrawal is assumed to come from contributions first, not earnings. Withdrawals that come from contributions aren't taxable (unless it's qualified money, which rarely happens). After the contributions are exhausted, then withdrawals are assumed to come from earnings.
Accurately computing the future value of a VUL policy borders on the impossible. Any single line projection of the VUL is, a) virtually certain to be wrong and b) without question overly simplistic. This is a rather complex beast that brings with it a wide range of potential outcomes. Remember that while we cannot predict the future, we know pretty much for sure that you won't get a nice even rate of return each year (though that's likely what all VUL illustrations will assume). The date when returns are earned can be far more important than the average return earned. To compare a VUL with other choices, you need to do a lot of "what ifs" including looking at the impacts of uneven returns, and understand all the items in the presentation that may vary (including your date of death (grin)).
While I hate to give "rules of thumb" in these areas, the closest I will come is to say that VUL normally makes the most sense when you can heavily fund the policy and are looking at a very long term for the funds to stay invested. The idea is to limit the "drag" on return from the insurance component, but get the tax shelter.
Another issue is that if you will have a taxable estate and helping to fund estate taxes is one of the needs you see for life insurance, the question of the ownership of the insurance policy will come into play. Note that this will complicate matters even further (and you probably already thought it was bad enough (grin)), because what you need to do to keep it out of your estate may conflict with other uses you had planned for the policy.
Note that there are "survivor VULs", insuring two lives, which are almost always sold for either estate planning or retirement plan purposes (or both). The cost of insurance is typically less than an annuity's M&E charges until the younger person is in their fifties.
A person who is considering purchasing a VUL policy needs to think clearly about his or her goals. Those goals will determine both whether a VUL is right tool and how it should be used. Potential goals include:
• Providing a pool of money that will only be tapped at my death, but will be used by my spouse.
• Providing a pool of money that will only be used at my death, but which we want to use to pay estate taxes.
• Providing a pool of money that I plan to borrow from in old age to live on, and which will, in the interim, provide a death benefit for my spouse.
Posted: Fri Apr 15, 2011 07:55 pm Post Subject: Tax Treatment of VUL if Cash Value Is Less than Premiums Pai
If one cashes in a Variable Life Insurance Contract and the cash value is less than the premiums paid, can the owner deduct the $3000 against earned income as they can with investments?
Posted: Sun Apr 17, 2011 01:18 am Post Subject:
Catherine . . .
When it comes to insurance products, such as Variable Life or Variable Universal Life, the whole discussion of CAPITAL GAINS disappears. That's one of the ways you would recognize that variable insurance products are NOT INVESTMENTS, they are insurance.
If you lost money on a mutual fund purchase, you could use the loss to offset up to 100% of your capital gains or up to $3000 of personal income in a tax year. If you lose money on an insurance contract, it's the same as if you flushed the money down the toilet.
The same rules apply to qualified retirement plans or annuities. If you have a loss, it is not deductible, and you take what you get. If you get nothing, oh well.
A similar rule applies to home ownership -- Uncle Sam might get you for capital gains on a "winning" sale, but he will not allow you to offset other capital gains or deduct a capital loss from personal income on the "losing" sale of your personal residence -- your home is not an investment, contrary to what banks and realtors tell you. Buy and sell homes as an "investor" and you can offset capital gains or deduct your capital losses with those losing sales.
So don't ever believe the agent (or insurance company) who wants you to believe your life insurance is an INVESTMENT. It never has been, and it never will be. Could it build cash value? Of course. But that is not CAPITAL GAIN -- and it cannot suffer a capital loss, the hallmark of a true investment.
Posted: Thu May 12, 2011 10:12 am Post Subject:
Max,
I must commend you on the amount of knowledge that you possess. The problem is that you seem to know about 90% of everything, yet seem to be confident that you know 100%.
In this case, you are making up your own definintions to prove your point. Who besides Max Herr would even attempt to define an investment by whether one can have a capital loss or not? That's a byproduct of our tax code and has nothing to do with whether something is defined as an investment.
By your logic, my purchase of Microsoft stock inside of my 401(k) is not an investment. A 529 plan is also not an investment. That's just plain old stupid. Don't confuse the tax code with what is and what is not an investment.
Is a prospectus needed? Is there a risk of loss? One can't answer "yes" to both of those and then claim something isn't an investment.
Variable life products are insurance. This doesn't mean that they are not investments.
Max, can you sell a variable product? The answer is "no". Why not? You have an insurance license. You don't have license to sell investments.
Do variable products require a prospectus? Yes. Why? They are considered investments. Does the prospectus call them an investment? Yes.
Max, I know that you'll respond that it is only the subaccounts that are investments, yet the subaccounts can't be purchased separately and although the money may be invested in a separate account, it's still part of one contract and a variable life policy is classified as a security. This is true even if all of the money is in the fixed account.
Go ahead and quote chapter and verse about insurance policies must be sold as insurance policies. That is true. However, if it is a variable policy, one can't gloss over the fact that is a security and must be sold as one also.
Max, in California, can a life insurance agent who is not a registered rep and can't charge for giving financial advice allowed to answer questions on securities in a public chatroom?
It is absolutely possible to have capital gains on an insurance product. One can claim a loss on an insurance contract.
Just so you don't make more of a fool of yourself, I'll give a quick example of both. Ex. Max has an insurance product with a basis of $50,000 and a cash surrender value of $70,000. He sells it for $80,000. He has a $10,000 capital gain. Ex. Max has a variable annuity with a basis of $100,000. He surrenders it for $50,000. Depending upon the rest of his tax situation, he may be able to take some or all of the loss. It isn't a capital loss.
I don't like variable universal life policies. Nobody should buy one because they want an investment. They should only be purchased because one believes that it is the best way to take care of their insurance needs. That doesn't stop them from being investments.....and insurance.
You'll be glad to know that this will be my only post. Best of luck to you.
Posted: Fri May 13, 2011 03:24 am Post Subject:
By your logic, my purchase of Microsoft stock inside of my 401(k) is not an investment. A 529 plan is also not an investment.
Actually, logic aside, that's correct.
And in a VUL you are "investing" (to allow use of that word) in subaccounts that are OWNED by the INSURANCE COMPANY -- you have no ownership of anything except an insurance contract that tells you how you can instruct the insurance company to deposit your money in your contract's cash accumulation. If it's not yours, you cannot deduct any losses -- more on that later. [And here's another clue, when you take a policy loan from any life insurance contract, you are borrowing the insurance company's other money, not yours, and not reducing the value of your cash accumulation. You pay interest to the insurance company, and it's all gravy to them. At least, in a 401(k) or 403(b), your holdings are liquidated to provide the funds you want to borrow, and the interest you pay on the loan is attributed to your account, not into the hands of the custodian.]
But, yes, when the VUL or retirement plan subaccounts are Management Investment Companies, they are regulated under the Investment Company Act of 1940, and their shares must be offered by prospectus through a FINRA member and/or registered rep.
No argument with that at all. To transact requires registration with FINRA as a general securities or variable investment products representative. Most states require a Series 63 registration in addition to the S-6 or S-7. When the product resides within an insurance contract, it also requires a life agent's license.
The subaccounts may include mutual fund-like creations, or perhaps even individual stocks, bonds, or ETFs. What's available in a VUL is determined by the INSURANCE COMPANY, not the insured. As an insured, you have no control over the selection of the subaccounts themselves, you only have the ability to allocate your cash value among the available choices.
Or it could go into a bank CD or money market account -- but I doubt anyone would call either of those an investment. Especially since they are not registered as securities.
The 401(k) plan, the 403(b) plan, the 529 "College SAVINGS" plan, like a VUL policy, is, itself, not an investment. It is merely a shelter from taxation (although the life insurance contract offers something none of the others do). That you may have internal choices that involve securities products does not change the essence of the PLAN/POLICY. And generally, you cannot hold life insurance as part of those plans, because that would be an attempt to change a taxable account into a non-taxable distribution at death. Perhaps that's what, apparently, is so confusing to people.
I guess, after all these years, I just haven't learned yet how much plainer I can make it so that insurance people can understand it. It's not a difficult concept, and my clients get it, but many in the industry have succumbed to all the marketing hype that the companies throw our way, and they cannot dissociate reality from hype.
I don't like variable universal life policies. Nobody should buy one because they want an investment. They should only be purchased because one believes that it is the best way to take care of their insurance needs.
Good for you! That, sir, is the essence of the debate. And you have it exactly 100% right -- up to that point. But VULs are not investments AND insurance, they are insurance with an investment component -- it both gives control over the rate of cash accumulation/decline AND all the risk of the contract collapsing to the contract owner. That's a significant difference that, apparently, few insurance people want to accept.
Ex. Max has an insurance product with a basis of $50,000 and a cash surrender value of $70,000. He sells it for $80,000. He has a $10,000 capital gain. Ex. Max has a variable annuity with a basis of $100,000. He surrenders it for $50,000. Depending upon the rest of his tax situation, he may be able to take some or all of the loss
Here your understanding of the tax code fails. NO INSURANCE PRODUCT IS, EVER HAS BEEN, OR EVER WILL BE, SUBJECT TO CAPITAL GAINS OR CAPITAL LOSSES. Period!
It is essentially the same thing with ownership of a personal residence. Your realtor, your banker/lender, and others will tell you your home is your biggest investment. It is NOT. For someone else's explanation of that concept, I recommend Robert Kiyosaki's book, "Cash Flow Quadrant" (and it would be a good idea to read his first book, "Rich Dad, Poor Dad" first).
Your mortgage is probably your biggest liability. Your home is a liability. Liabilities take money out of your pocket. When you sell your home, you can end up with a taxable gain, but you cannot deduct any capital loss if you sell it for less than your cost basis. The government regards your home almost the same way it regards life insurance for tax purposes, but it never regards your primary residence as an investment.
You can own other real estate, rent it to others to live in, and you can deduct 100% of your expenses to maintain that property, and you can sell it for a loss, and use the loss to offset other capital gains. You cannot do that with your primary residence.
The only way to obtain any credit for a loss on an insurance contract is on a person's final tax return after death. And, even then, it is not connected to the surrender of the policy, it is only connected to leaving principal with the insurance company because of a lifetime settlement option that didn't pan out due to early death. And it's still not considered a capital loss, it simply reduces taxable income. It FAILS the test of an investment.
Any other "loss" associated with an insurance product is a NON-DEDUCTIBLE loss. For the same reason that you cannot deduct the insurance premium/annuity purchase payment. The tax code does not permit it.
It is absolutely possible to have capital gains on an insurance product. One can claim a loss on an insurance contract.
Go ahead and try it. Then let us know how much you had to pay in penalties and interest for the miscalculation. Or quote the IRC section that you believe allows it (but you can't, because it does not exist).
Just so you don't make more of a fool of yourself,
Sorry to burst your bubble, but I have to turn this statement around on you.
Is an agent . . . allowed to answer questions on securities in a public chatroom?
Of course. Anyone can answer questions. Just can't give direct advice or effect securities transactions. As a former registered rep/principal (S-6, 63, 26), I am free to share my knowledge with anyone anywhere.
Posted: Fri May 13, 2011 02:22 pm Post Subject:
Max,
To know as much as you do and yet be so wrong about so many things is truly astounding.
NO INSURANCE PRODUCT IS, EVER HAS BEEN, OR EVER WILL BE, SUBJECT TO CAPITAL GAINS OR CAPITAL LOSSES. Period!
Are you sure that you want to be yelling this from the rooftops. It makes you look pretty silly to those of us who understand this better than your students.
Does your crystal ball know anything else about the future of our tax code? I don't know if your crystal ball is correct about the future. I can tell you that it's wrong about the present. Take a look at Revenue Ruling 2009-13. When a life insurance policy is sold for a gain, the gain above the cash surrender value of the policy is a capital gain. It's a shame that you will take the time to read this, but instead of admitting that you were wrong will try to twist things around.
Your example of borrowing is irrelevant. One can't ever borrow their own money. If one borrows from a variable policy, the first thing that happens is that money is moved from a variable sub account to a fixed account. The person does borrow the insurance company's money. This is not "all gravy" to the insurance company. If they weren't lending money to the insured at 6% (or whatever the rate happens to be), they would have that money to invest elsewhere. Policy loans, from the insurance companies perspective, are the same as any other investment that they make.
A 401(k) or 403(b) does not need to be an investment. One doesn't necessarily need to be securities licensed to set up these accounts. However, you are wrong about a 529 "College Savings" plan. 529 plans are "Municipal Fund Securities" and one must be registered to sell these plans.
For you to argue that Microsoft stock inside of a 401(k) plan is not an investment makes absolutely no sense. And, by the way, don't forget that it is possible to have CAPITAL GAINS (yes, I'm yelling) with money that comes from a 401(k) plan. As someone with just a Series 6, you would have never dealt with this situation. Feel free to yell some more if you'd like me to offer you proof that I'm correct.
Any other "loss" associated with an insurance product is a NON-DEDUCTIBLE loss.
Max, wow more yelling while you are wrong. Talk to some CPA's. A loss on a non-qualified annuity can be taken as a miscellaneous deduction.
Let me ask you about you saying that "anyone can answer questions." You may be able to do so as "former registered rep", but you probably couldn't do it if you were a "current registered rep". This is because it is considered advertising. As such, it would all need to be approved by your B/D and they most likely wouldn't allow it.
From a securities perspective, what you are doing here, would certainly be considered advertising. I would think that the same would be true from an insurance perspective, thus, the need to have you CA insurance number. Can you get in trouble here for your advertising since you are reaching people in places where you are not licensed?
You really do need to, at least, stop talking about variable products since you are both unlicensed and frequently wrong.
Posted: Sat May 14, 2011 12:03 am Post Subject:
Here we go again:
fjaksv,
You've made several great points here. I am not qualified as an Expert in the application of the tax code to life insurance matters. Because you seem fairly well versed in this area, maybe you could answer a question for me:
According to Revenue Ruling 2009-13, any profit [gains] received from the sale or surrender of life insurance is taxable as ordinary income. However, in your example you've classified these as "capital gains." Are the capital gains in your example taxed differently?
Posted: Sat May 14, 2011 01:19 am Post Subject:
Ex. Fred has a policy with a cost basis 50k and a csv of 60k. He sells it for 90k.
Taxes:
Ordinary income 10k
Capital gaims: 30l
Posted: Sat May 14, 2011 01:53 am Post Subject:
Interesting thread. From my experience, and I am not a CPA or giving tax advice, the gains on the sale of a life insurance policy are taxed as capital gains over cost basis like fjaksv stated. I would always recommend someone seek the advice of their CPA on the matter. It gets even more complicated with a term insurance policy that's converted and sold. I've heard from some sources that only the gain above the premiums paid for the term insurance are taxable and from other sources that as soon as the policy is converted, the cost basis resets to $0 and all gains are taxable since it is a separate policy being issued.
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