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From Mark Ford, founder, Palm Beach Research Group: When Tim Mittelstaedt and Tom told me back in 2012 they wanted to recommend Income for Life to our readers, I objected.
“The only sort of life insurance we should recommend is term insurance,” I told them.
But they insisted I had it all wrong.
Well, I wasn’t going to go down without a fight…
Are these returns for real?
Me: Let’s start with this guaranteed return. I simply don’t believe it.
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Tim Mittelstaedt, editor, Income for Life Premium: We’ve got access to the results of how quite a few policies have performed.
One of the mutual insurance companies we follow performed a study of how projected policy returns measured up over a 30-plus year period.
For example, the insurance company projected a $250,000 whole life insurance policy issued in 1980 on a 35-year-old non-smoker. It showed the cash value balance would be $332,426.
Based on the premiums this person would pay, that would be equivalent to earning 4.44% on that cash every year for 34 years.
How did the policy actually perform?
Well this same policy’s actual cash value balance was $433,187. That’s the equivalent of a 5.65% return every year for 34 years. That means it’s performed better than originally projected in 1980.
Me: Okay. So the return on investment is backed by the company itself. How safe is that?
Tim: The company has paid policyholders returns every single year since 1860… over 150 years.
Now, I’ve told you about the 4% guaranteed returns… but I haven’t even mentioned the dividend. When you factor that in, the total growth rate can be 5% or more.
Me: So where does the dividend come from?
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Tim: Mutual insurance companies are businesses. They generate income through premium payments coming in from health insurance, auto insurance, home insurance, and life insurance.
They also earn profits from investing in (normally) safe vehicles such as bonds and other debt instruments.
On the expense side, they pay out claims when they arise, as well as the normal operating expenses such as salaries, office expenses, and agent commissions.
They also set aside some of the profit in reserves.
The leftover profits get distributed to the whole life insurance policyholders in the form of dividends.
Different from the 4% promise, these dividends are not guaranteed. But the mutual companies I’ve studied have been paying dividends 100-150 years in a row without a single exception.
Me: I can see how such a long, unbroken history of payouts to policyholders could give an investor comfort.
But times change, and companies change with them. These mutual companies may have been strong for 100-plus years—but how do I know I can count on them in the future?
Tim: These are the safest institutions on the planet. They invest in the safest bonds, with a very small portion in mortgages backed by quality A-plus real estate.
They have been profitable through two world wars, the Great Depression, the interest rate shock in the 1980s, and countless other financial disasters. And the most recent financial fiasco—the meltdown of 2008—was no exception.
What happens when you factor in taxes?
Me: What about taxes? How does that work?
Tim: Income for Life offers a combination of tax-deferred and tax-free growth. Policyholders are not required to report their policies, their dividends, or their interest to the IRS.
Your dividends are always tax-free, no matter what.
And once you want to start withdrawing additional money, you can take out what you paid in, tax-free.
This is because the IRS views withdrawing the money you paid in and the dividends you received as a return of your premium payments. It doesn’t view life insurance dividends the same way as regular stock dividends.
If you then wanted to withdraw more from your policy (factoring in the appreciation) than what you paid in, you’d have to start paying taxes on those withdrawals. Meanwhile, that money would’ve been growing tax-deferred.
But… with the Income for Life strategy, there’s a way to change the tax-deferred portion of your money to tax-free.
Me: That doesn’t sound legal. It makes me uncomfortable.
Tim: It’s perfectly legal. There are no taxes owed on money you pull out up to your cost basis (what you paid in). If you kept withdrawing cash after your cost basis, you’d have to pay taxes. But instead of taking withdrawals from that point on, you can start taking policy loans.
Let’s say you’ve accumulated $1 million in cash value. Then, let’s say you need to take out $30,000 each year for whatever reason. In the first 10 years, you take a straight withdrawal. You pull out $300,000 tax-free. That’s your cost basis (what you paid in).
In year 11 and beyond, you take that $30,000 amount in the form of a loan from the insurance company.
It’s like income in that you still have $30,000 in your bank account each year to spend however you want, but the IRS won’t tax you in year 11 and beyond. Why? Because you’re taking a loan from the insurance company, not a withdrawal from your policy.
And here’s the trick: It’s a loan you never intend to pay back.
Getting back to our example: Let’s say you take a $30,000 loan each year for 20 years. You’d have $600,000 in outstanding loans. You don’t need to worry about that, though, because it will be settled by the insurance company.
For example, if you have a $1.5 million death benefit in your policy, they’ll keep $600,000 of that when you die to pay off the loan. Then they’ll give the remaining amount of $900,000 to your estate.
Me: So you are paying the taxes. You’re paying them with your death benefit.
Tim: No, you’re just paying off the policy loan you have with the insurance company. The rest of the proceeds—$900,000—are tax-free. (Death benefit proceeds are always free of income tax.)
What about agents’ commissions?
Me: Let’s talk about my big problem with whole life policies: The agents’ commissions are huge. On a single-premium policy, for example, they can range from 50-100%.
Tim: Traditional whole life policies are set up to provide policyholders with as much death benefit as possible. And since the agent’s commission can be as high as 100% of that first-year payment, you end up with $0 in cash value the first year… and very little in years two and three.
But there’s something called a “paid-up additions (PUA) rider.” And it changes everything.
Using this rider the way we recommend minimizes the death benefit to the lowest level possible. It also slashes the agent’s commission up to 70%.
So instead of 100% of the first premium payment going to the agent’s commission, only 30-40% does.
Lower death benefit focus means lower commissions. But you can’t lower the fees any more than that. If you did, the IRS would look at your policy and say, “That’s not life insurance. You’re just using it to avoid paying taxes.”
Getting the fees down to 30-40% of the first year payment is the lowest legal limit before you lose the tax-deferred growth benefits.
And what’s this about becoming my own bank?
Tim: A major advantage of Income for Life is you can use it to borrow money. My insurance company is willing to give me a loan for up to the amount I have in cash value.
They’ll do it anytime, no questions asked.
Me: But there are other ways to get the same convenience. If you maintain a significant cash balance with your bank, they’ll likely give you a line of credit. Or if you have municipal bonds with a broker, he’ll lend you money against them.
What are the typical borrowing costs?
Tim: The companies we’re recommending to PBRG readers offer rates between 4.5% and 6%. (Others charge as much as 8.5%.)
Me: I can borrow money much more cheaply than that—and, in fact, I’m doing it with two lines of credit I’ve opened for business purposes. One is with Bank of America at 3.1%. The other is with Raymond James at 1.7%.
Tim: Yes, but that’s because you pledge those credit lines against assets you have with those institutions.
Me: You’re right about my credit line with Raymond James. It’s backed by my bond account. And I can’t withdraw that collateral without collapsing the line of credit.
But my credit line with Bank of America is not collateralized. It’s based on my history of keeping a large cash balance—which, in all fairness, isn’t true for most people.
And how’s that any different from what you do? You can borrow only up to the cash value of your account. Isn’t that the same thing?
Tim: It’s almost the same thing. Borrowing against the cash in my policy allows me to double compound my money. My money continues to grow in the policy. And the insurance company loans me money that I can use to invest.
You’ve found a way to do the same thing. You invest in bonds. And you’ve established a line of credit against those bonds. You can borrow from your broker and invest. Your rates are great.
But let me ask you a few questions…
Even though you have a broker, don’t you still have to oversee your bond account? You don’t have to do that with the IFL policy.
Is your bond portfolio safe against lawsuits or creditor claims? In most states, it’s virtually impossible for anyone to get to your life insurance policy.
And does your bond portfolio have a death benefit? That’s the biggest missing piece to me. The death benefit is not the primary reason we’re setting up these policies. But it’s a phenomenal perk that can give the average person more retirement income options.
So, yes, you are effectively doing the same thing. You can borrow against your bonds and invest the money to “double compound.” And you have a cheap cost of capital.
But I’d wager most of our readers can’t get the same terms… or don’t have multimillion-dollar bond portfolios like you do, Mark. And your bonds don’t come with a death benefit.
Me: Okay, I must say it sounds pretty good. Especially for people like you guys—who are relatively young and don’t have assets you can use as collateral.
But I have two more concerns. And they are not minor.
The caveat
Me: If I understand it correctly, when you open an Income for Life policy, the idea is you must continue to make premiums for the rest of your life. Is that true?
Tim: Yes. And this is important. You really shouldn’t open a policy if you don’t plan to keep it in force for your lifetime.
Because of the initially higher commission in the first year, you’ll lose money if you cancel the policy after just a few years. It takes a while—usually four to seven years—before the cash balance in your policy equals the premium payments you’ve paid in.
Also, because the whole idea of the account is to take advantage of tax-deferred saving on a long-term basis, the strategy becomes more efficient with each year that passes. Dividends get higher and the cash value increases.
That’s why we’re very clear in explaining why you should never cancel an Income for Life policy.
Me: But having to pay into the policy every year for the rest of your life—that is onerous, isn’t it?
Tim: Actually, Mark, it’s not. Eventually, there’s enough cash and dividends in the account to cover all future premium payments.
At that point, the policy basically covers itself.
If you start off with a large first-year premium payment, it’s possible to have the account go on autopilot in year three. But for a lot of our older readers, it’ll take considerably longer—between five and 10 years.
The bottom line
I’ve come to believe the Income for Life program can be a good and useful part of many wealth-building plans. Its primary benefit—the 5% (4% guaranteed plus 1% in dividends) compounded, tax-free return—is very difficult for most ordinary investors to replicate.
And if you choose the right company to deal with (one that allows you to borrow money cheaply), the loan feature can be a safe and sensible way to “be your own banker,” as they like to say.
My endorsement is based both on the knowledge I’ve acquired from my many discussions with Tim and Tom and on my own personal experience, being four years into this sort of program with one of my clients.
It’s a particularly attractive policy for young people, who have so many years of appreciation ahead of them. But it can also work for middle-aged people who want to leave money for their children or for charity.
If you like the policy, I’d begin conservatively by allocating a portion of your investable income and/or investable net worth to it. Then increase it later on, if you want.
Reeves’ Note: Income for Life is the only system we know of that allows you to safely grow your money tax-free at rates 30 to 40 times faster than a savings account. That’s why Mark now has over $1 million in his own whole life policy. But there’s more than just safety to this approach… Click here for full details.