The Simple Answer
For asset protection and tax-free growth,
investors may need to look no further than your basic
investments of life insurance and annuities. However, each
state’s laws shield these investments to varying degrees.
We have been helping the medical community
shield assets from potential lawsuits for years. While we
regularly establish sophisticated trusts, limited partnerships,
captive insurance companies, and even offshore arrangements to
protect our clients’ assets and help them save taxes,
often we need not be that creative.
In fact, in many
states, the law gives us two tremendous opportunities to
protect wealth and lessen income taxes through life insurance
and annuities. If shielding your net worth from a potential
lawsuit is important to you and if you would like to pay less
in income taxes, you must consider these tools as part of your
financial plan. The question then becomes: If you have a
choice between two fairly equal investments, why not use the
one that is asset-protected and enjoys special tax treatment
under the law? Typically, the wise choice is to make use of the
asset-protected, tax-deferred investment. Let’s see how
that works.
State protects investments
Every state has laws that shield certain
assets from creditors. These are called “exempt
assets,” as they are exempt from seizure in a lawsuit or
in bankruptcy. What types of assets are afforded this
protection? Most common is the IRA (only in some states) and a
portion of the primary residence through what is called a
“homestead exemption.” Many states also protect
life insurance policies and annuity contracts.
When we refer to life
insurance policies here, we mean “cash value”
policies or what is called “permanent insurance.”
Unlike term insurance, which just provides a death benefit,
cash value policies have a cash account, which is not limited
in size. You conceivably could have life insurance policies
with hundreds of thousands, if not millions, of dollars in cash
account value and still enjoy all of the asset protection and
tax-deferral benefits under the law. Whole life, variable life,
universal life, and variable universal life—these are all
types of cash value insurance. Under tax law, the growth in
these policies accumulates tax free. Withdrawals and policy
loans can be taken against the cash account tax free as well.
In this way, cash value life insurance enjoys superior tax
treatment as compared to any other liquid investment (stocks,
bonds, CDs, etc.).
What can you expect in
terms of rates of return within permanent insurance policies?
That will depend on the type of policy. Variable and variable
universal policies are invested in mutual funds, so your return
will depend on the performance of the funds you choose.
Universal life policies often have a guaranteed crediting rate
(the company guarantees this rate of return) and an actual
current crediting rate (what the policies returned in the last
year). Many AAA-rated insurance companies have policies now
where the guaranteed crediting rate is two to four percent,
while the actual crediting rate was four to six percent. Whole
life policies are typically the most stable policies, where the
company pays its dividends first. Whole life policies from
AAA-rated companies have paid between five and eight percent
annually each year for the past 10 to 15 years.
Life insurance: protected everywhere
Life insurance can protect you by not only
assuring financial protection for your heirs, it can also grow
tax free and shield your investment capital from creditors to
varying degrees. All 50 states have laws protecting life
insurance, but they each protect different amounts. Some
general trends:
• Most states shield the
entire policy proceeds from the creditors of the policyholder.
Some also protect against the beneficiaries’ creditors.
• States that do not protect
the entire policy’s proceeds set amounts above which the
creditor can take proceeds. For example, Arizona exempts the
first $20,000 of proceeds.
• Many states protect the
policy’s proceeds only if the beneficiaries are the
policyholder’s spouse, children, or other dependents.
• Most states also exempt the
proceeds from term and group life policies.
• Some states protect a
policy’s cash surrender value in addition to the
proceeds. If you have substantial cash value in a life
insurance policy, be sure to consult your state’s
exemptions to determine how well protected you are.
(See www.assetprotectionbook.com/state_resources.htm)
(See www.assetprotectionbook.com/state_resources.htm)
Annuities also often shielded
There are two types of annuities:
variable annuities and life annuities. Variable annuities
are insurance contracts that invest the contributions into
investment vehicles on a tax-deferred basis. These tools can be
useful for clients trying to grow wealth in a tax-favored
manner for retirement. On the other hand, a life annuity is an
insurance contract where the investor pays a certain amount of
money up front, and the insurance company then pays the
investor back at a fixed payment every month, quarter, or year
for as long as the investor (or the investor’s spouse) is
alive. These annuities are best for retired clients who
don’t want to “run out of money” during their
old age. Because the issuing insurance company pays out each
month or year regardless of how long the annuitant lives, life
annuities are a great tool for protecting against living too
long. Think about them as the opposite of life insurance (which
protects against dying too young).
Many, although not
most, states protect annuities from creditor claims. In the
states that do exempt them, annuities are an ideal tool to
safeguard wealth. Let’s consider an example:
Case Study: Sam chooses between mutual
funds and a variable annuity
Sam is a physician concerned about asset
protection, as he has seen a number of malpractice judgments
financially cripple physicians in his medical community. Sam
now has $50,000 to invest and is in a state where variable
annuities are protected. His decision is whether to invest the
money in mutual funds or in a variable annuity. He knows that
annuities have higher charges than mutual funds. However, for
that higher expense, Sam would enjoy tax deferral and asset
protection.
The annuity could be
invested in the same underlying mutual funds that Sam is
alternatively considering, so the rate of return would be
identical. Let’s assume that the annuity charges about an
additional 1.5 percent annually. Is it worth it for Sam to use
the annuity when it is protected and grows tax-deferred rather
than the mutual fund? We can’t say for sure without
knowing more about Sam’s goals and portfolio, but ask
yourself: Would you pay an extra $750 per year to protect
$50,000 from all potential lawsuits and grow those funds
tax-free?
Conclusion
If asset protection and tax reduction are
important to you, learn which assets are protected in your
state. Once you do, you will have a better idea of how to
optimize such investments in your financial plan. g
David
B. Mandell, JD, MBA is an
attorney, lecturer, and author of the book Wealth Protection: Build and Preserve Your
Financial Fortress. He is also a
co-founder of The
Wealth Protection Alliance, a
nationwide network of independent financial advisory firms. H.
Ryan Coker, CLU, ChFC, AEP is a principal of
The Benefit Company, in Atlanta, GA and provides business planning to physicians and corporations
nationwide. Reach him at 1-800-554-7233.
The Benefit Company, in Atlanta, GA and provides business planning to physicians and corporations
nationwide. Reach him at 1-800-554-7233.
