Your conservative portfolio is at risk

IT'S AMAZING HOW often the voice at the other end of the phone says something like, "Irv, I'm very conservative." Then they prove it. How? By telling me they have parked all or a large amount of their extra cash in what they consider " conservative investments." Most conservative investments are in low-yield, fixed-rate stuff like CDs or U.S. Treasury bonds. But municipal bonds are the handsdown favorite

IT'S AMAZING HOW often the voice at the other end of the phone says something like, "Irv, I'm very conservative." Then they prove it. How? By telling me they have parked all or a large amount of their extra cash in what they consider " conservative investments." Most conservative investments are in low-yield, fixed-rate stuff like CDs or U.S. Treasury bonds. But municipal bonds are the handsdown favorite conservative investment.Here's a well-known fact: When inflation rears its ugly head, conservative investments are anything but conservative. Consider just one additional value-eating bandit who walks handin-hand with inflation — interest rates.

Here are the three ways that the bandit steals your money and hard-earned wealth when, for example, you are heavily invested in municipal bonds:

  1. The value of the bonds goes down as interest rates go up.
  2. You are locked into a low interest rate until the bond matures or you sell it (probably at a painful loss).
  3. Nasty inflation reduces not only the value of the interest you receive, but also the already reduced value of the bond (see No. 1 above) has less buying power due to inflation.

Here's a quote from the Currency Options Hotline Operating Manual that drives home the devastating economic impact of inflation over time.

"... [I]f you were somehow able to take one of today's greenbacks [dollars] back in time to 1940, you would find it worth only about 6.5 cents."

Sorry, but it looks like inflation (plus the falling value of the dollar against most foreign currencies) will be our rather unwelcome bedfellow for at least the foreseeable future. What is a conservative investor to do?

Actually, we all know the answer. Find an investment vehicle that overcomes the three evils of the rising-interest rate bandit. First, let's outline the attributes of such an investment; second identify the investment; and finally, give an example of how the investment works.

OK, here come the attributes of the investment:

  • A higher rate of return than on traditional conservative investments such as CDs, treasury bills and notes, and, of course, municipal bonds;
  • The interest rate tends to go up as inflation goes up;
  • Your investment will never go down in value and, in fact, will always guarantee you a profit;
  • The interest earned and your investment profit is income tax-free; and
  • Your total investment at time of death (original investment, interest earned and profit) escapes the clutches of the estate tax ( when properly structured).

And now, a drum roll please, the identity of the investment. It's a particular type of life insurance, which I call conservative investment life insurance or CILI for short.

Finally, let's look at an example. (Note: This investment concept works for any age but is typically used by an individual or married couple who is age 50 or older.) In this example Joe and his wife, Mary, are both 70 years old. They buy a $1 million second-to-die CILI policy (it could be any amount) with an annual premium of $23,516. The policy currently earns 5.7%.

The payoff on Joe and Mary's investment comes after the second death and is always determined as follows. (This example assumes the policy is in force for 10 years and, at age 80, both Joe and Mary are hit by the same bus.) Their heirs (kids and grandkids) would receive:

  • Death benefit: $1 million;
  • Premiums paid: $235,160 ($23,516 x 10 years);
  • Interest earned on premiums paid: $75,411 (calculated at 5.7% but would be higher if interest rates rise or lower, if interest rates fall);
  • Total amount (tax-free) to heirs: $1,310,571

Next, suppose the second death (of Joe or Mary) happens at age 90. Their heirs would get a total of $1,816,458 (tax-free).

The easy way to summarize the investment is as follows:

  1. You get your investment ( premiums paid) back, dollar-for-dollar;
  2. Plus earnings ( 5.7% here, but probably higher because interest rates are rising);
  3. You get a guaranteed bonus, the death benefit (here $1 million); and
  4. It's all tax-free (no income tax, no estate tax).

You may want to know how a CILI might work for you, your Mom and Dad or your grandparents.

So, I have made arrangements for readers of this column to get all the information you need and your questions answered. Just fax your name and birthday (same for your spouse, if you're married), address and phone numbers (work, home and cell) to Irv Blackman at (847) 674-5299.

Irving Blackman is a partner in Blackman Kallick Bartelstein, 10 S. Riverside Plaza, Suite 900, Chicago, IL 60606; tel. 312/ 207- 1040, or via e-mail at iblackman@bkbcpa.com.

TAGS: Taxes