THESE ARE TOUGH times for investors. The stock market mimics a roller coaster. Uncertainty prevails. The conservative investor struggles to find safety.
What to do?
That’s a question many readers of this column ask, particularly conservative investors. The simple answer is to find an investment with a higher rate (say in the 5% to 6% range) of return. And make the earnings income tax-free. Then toss in a substantial profit on the principal amount invested, also income tax-free. Of course, it must be safe. Just to round out this dream-like investment, make everything (your principal, profits and earnings) estate tax-free.
Is this a fantasy or a reality?
Happily, it’s a reality. The economics of the investment described above are easily accomplished, and the tax law (for both income taxes and estate taxes) shields you from the IRS.
What is this investment? It’s a particular type of life insurance.
An example (prepared by my insurance guru, David Greenspahn from Winnetka, Ill.) is the easiest way to quickly grasp the economics and tax consequences of CILI.
Here’s the example: Joe and Mary, husband and wife and both 70 years old, buy a $5 million dollar CILI policy. The annual premium of $117,580 is payable as long as either Joe or Mary is alive, but premiums stop at age 100. Joe and Mary are in a 55% estate tax bracket (assume the second death occurs after 2010). Current earnings for the CILI are 5.7%.
First, let’s look at what Joe and Mary’s heirs would receive after 10 years (assuming they got hit by the same bus).
Basic policy death benefit: $5 million.
Premium: $117,580 X 10 = $1,175,800.
Total death benefit: $6,552,854.
Next, suppose Joe goes to heaven at age 82 and Mary follows at age 90. Premiums would total $2,351,600 ($117,580 X 20) and the total death benefit would be an astounding $9,082,290. What is the profit of the CILI investment? An amazing $6,730,690 (just subtract the premiums — $2,351,600 — from the death benefit — $9,082,290).
Finally, assume Mary makes it to age 100. The total premiums would be $3,527,400 ($117,580 X 30). Want to guess the total death benefit? A whopping $13,202,474, a profit of $9,675,074.
Let’s return to the age 90 example and ask this question: What was the real out-of-pocket cost to Joe and Mary for the 20 years of premiums? The fact is that the $2,351,600 premium cost is gone. It’s no longer in Joe or Mary’s estate to be subject to the 55% estate tax. Put another way, they saved $1,293,380 in estate taxes ($2,351,600 X 55%). So, the real cost of the investment in the CILI policy is only $1,058,220 ($2,351,600 minus $1,293,380).
A little summary: In the age 90 example, Joe and Mary realized a profit of $8,024,070, (all taxes paid in full) on an investment of $1,058,220. The profit is the total death benefit of $9,082,290 less the real out-of-pocket cost of the CILI policy of $1,058,220. An after-tax profit of 858%.
It should be noted that the Internal Revenue Code kills the income tax for CILI, while an irrevocable life insurance trust is used to kill the estate tax. Yes, the plain fact is CILI is a real-life insurance product and is protected by the same rules that apply to any other life insurance policy.
But, no, it is not the right vehicle to get the best bang for your buck if you really need life insurance. That’s a story for another day.
It should also be pointed out that earnings might fluctuate. In general, if interest rates go up — very likely, earnings (now at 5% to 6% range) — probably will go up. If rates go down, earnings should also go down. As a result, your earnings — like any other interest sensitive investment — will vary. But 100% of your investment (premiums paid), plus the basic policy death benefit (pure profit) will always go to your heirs.
So, who should buy CILI? A conservative investor. If you are looking to make a killing on your investment dollars, CILI is not for you. Re-read the examples above. They reflect your most likely profit and earnings. Your age, health and number of years you (could be one individual or a husband and wife) live will affect the ultimate outcome. If you (or both husband and wife) are 55 years or older (up to age 90), you might want to take a look at CILI.
How much should you invest per year? Probably a minimum of $15,000. There is no maximum. If necessary, can you borrow from the cash surrender value of the policy? Yes, and it’s tax-free (the loan will be deducted from the death benefit).
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 [email protected].