A well-guarded investment secret

Feb. 8, 2013
Small business owners (SBOs) have many legitimate complaints these days: taxes, regulations, competition (from home and abroad), can’t find good people, etc. The list goes on and on. Always has. Always will.

Small business owners (SBOs) have many legitimate complaints these days: taxes, regulations, competition (from home and abroad), can’t find good people, etc. The list goes on and on. Always has. Always will.

Almost all successful SBOs accumulate excess cash not needed in their business. Naturally, they invest these funds. Over the years the quote that follows has been nicknamed the SBO’s lament: “I know how to make money in my business, but when it comes to making money with my investment money, either I don’t have time to watch it, don’t know how to watch it or I rely on my investment advisor. When the market is up, my advisors do fine… when it’s down they do lousy.”

For the past couple of years, the lament usually ends with, “Now the market is lousy. What should I do?”

Many investors have abandoned the stock market (read “Wall Street”) and have turned to investing in CDs, tax-free bonds, U.S. Treasury notes or similar so called “safe” investments and must tolerate the pain of paltry rates of return. Often these rates are lower than the annual inflation percentages. Sadly, their wealth erodes. Is there an alternative? Yes! Keep reading, you are about to be delighted.

Here comes the alternative to the Wall Street risks and the low-yielding safe investments … life settlements.

Life settlements

A Life settlement (LS) is simply, the purchase of an existing life insurance policy from a senior (typically 65 years old or older) by an investor. The selling senior, who no longer wants to pay premiums, gets a much larger price for the policy than taking the cash surrender value (CSV) from the insurance company. The senior wins. The investor wins by making a large profit without risk (the senior is sure to die).

The best way to understand the LS concept is by the following example: Joe, 79 years old, owns a life insurance policy with a $500,000 death benefit and an $80,000 CSV. Joe would like to stop paying premiums. Of course, he can cancel the policy and get the $80,000 CSV from the insurance company. An investor (really a group of investors) buys Joe’s policy for $160,000, paid in cash to Joe immediately. The investor now owns the policy and must continue to pay the policy premiums. The investor will receive the $500,000 death benefit when Joe dies.

Why the secret?

There are basically two types of life insurance policies: permanent (have CSV) and term (no CSV, which are never used in an LS transaction). According to Milliman and Robertson, an international actuarial firm, 89.5% of Universal Life policies (have CSV) never result in a death claim. The policies are either surrendered, or worse, allowed to lapse.

Note that universal life is the most common type of permanent life insurance sold in the U.S. Terminated policies are highly profitable for insurance companies. Of course, they want to keep the entire life settlement industry a secret. Why? Well, go back to Joe’s example. If Joe had cashed in his policy for the $80,000 CSV, the life insurance company would have been off of a

$500,000 death benefit hook. The insurance companies love people like Joe when they terminate their policies.

It’s easy to see why Joe is delighted with his $160,000 LS. Of course, the insurance company is anything but delighted and would like to keep LS a secret. The pure economic fact is that LS investors stand tall in the profit shoes of the insurance company. Here the investor stands to profit with a gross of $340,000 ($500,000 death benefit less an acquisition cost of $160,000), reduced by future premiums (until Joe passes on).

Paving the way

For many years, LS were the sole playground of institutional investors: large companies, such as CNA, Morgan Stanley and Citibank. In the May 18, 2005, issue of the Wall Street Journal an article titled, “Moving the Market…” states, “AIG has bought less than 1,500 policies since 2001 … A few years ago, Berkshire Hathaway Inc., the investment vehicle of billionaire investor Warren Buffett, began buying life settlements, according to securities filings.”

These five giant companies (and other big hitters) provide immense credibility to the LS concept because of the due diligence required before committing to invest their own dollars. Big hitters invest in LS because it is the ideal alternative to low-yield, fixed-rate investments; no correlation to stocks or bonds; LS policies are underwritten by highly rated (A or better) insurance companies; return of principal and profit is tied to death; and a portfolio of policies helps reduce volatility and risk. Interesting ... My estate planning clients want alternative investments (to Wall Street) for exactly the same reasons.

Becoming an investor in LS

A new fund called Tall Oakes Life Settlement Fund has been established to allow the smaller investor to get into the LS profit game. Tall Oakes will acquire the policies and become owner and beneficiary. As policies mature, the fund will make distributions based on available proceeds to the investors.

The average age of all insureds in the fund portfolio is targeted to be in the excess of 80 years old. Average life expectancy is projected to be 54 months. The term of the fund will be eight years. Finale distributions will be made at the end of the year eight by selling any remaining policies that have not yet matured and liquidating the fund. The targeted annual compounded rate of return for each investor is between 8% to 10%.

Tax consequences

The tax consequences of an LS investment are as follows:

  • Taxable:These are your own funds or funds you control (like your corporation or other business entities, family limited partnerships and any non-charitable trust.) There are only two simple rules: the tax on your profit is deferred until you actually receive your principal and profit, and your profit is taxes as ordinary income.
  • Tax-deferred:Almost everyone can play this profitable game via their qualified plan (IRAs – traditional or rollover, 401(k) plan, profit-sharing plan and any other qualified plan). The trustees of pension plans or other plans that are not self-directed can join the profitable fun by investing the plan funds in LS for the benefit of all participants.
  • Tax-free:A Roth IRA can fatten your tax-free accumulations. Charitable entities (like a family foundation, charitable lead trust or charitable remainder trust) are a perfect fit.

And finally, if you want to make a killing on your investments, LS is not for you. But if a high rate of return, with no Wall Street risk is of interest to you (or your IRA, 401k or other qualified plan), fax me (847-674-5299) your name, address, phone numbers (business/home/cell) and estimated

amount to invest (the minimum is $100,000 for accredited investors). Have a question? Call me, Irv, at847/674-5295.

Irv Blackman, CPA and lawyer, is a retired partner of Blackman Kallick LLP and chairman emeritus of the New Century Bank, both in Chicago. He can be reached at 847-674-5295, e-mail [email protected], or on the Web at: WWW.TAXSECRETSOFTHEWEALTHY.COM.

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