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Corporate Investors Want To Buy Insurance On Your Parents.
Why Shouldn’t You?

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Date : August 5, 2008

 

Dear Valued Reader,

There has been much to do about life settlements in the financial planning and insurance industries.

Stranger owned life insurance (SOLI)

“Traditional” life settlements are great for the seller as they are typically selling a policy they do not need in return for cash that they do need.

However, SOLI is a different story.

SOLI is the concept of “finding” a person’s life to insure who has no real interest in purchasing the policy, setting up a scenario where the insured is loaned money (typically non-recourse) to buy a new policy with the idea that the policy will be sold to a corporate investor in 25 months (after the contestability period of the policy).

Example:

Greedy insurance agent finds an insured that is 70 years old. The agents says to the insured, how’d you like to get a “Free” death benefit for the next two years and a big check by a corporate investor to buy the policy from you 25 months after you purchase the policy?

The lender will loan you $450,000 non-recourse and you can purchase let’s say a $1,500,000 life insurance policy.

In the 25th month, the corporate lender (or an affiliate company) will then buy the policy from the insured for $50,000.

What’s the insured going to say?

The insured should say what’s the catch? (And there could be a big one in the form of taxes due, but the insured is going to say: where do I sign? most of the time).

Why do corporate investors invest in buying life insurance policies of elderly people?

It’s pretty simple, for the guaranteed tax-free investment return.

If you buy policies in bulk, the average insured is going to die right around age 85.

Everyone is going to die at some point and so long as the premium is paid, the investor will eventually get paid off with a “TAX-FREE” benefit. There are no capital gains taxes or income taxes due on the death benefit.

Let’s look at the finances of our example. $400,000 compounded annually at 7.5% (net) would yield an account value of $1,431,357 at age 85.

The $1,431,357 is a “net” number. If we used realistic expenses for capital gains and dividend taxes, the investor might net approximately 4.25% annually which would leave an account balance of $875,850.

Therefore, you can see why a corporate investor would want to invest in the purchase of life insurance policies owned by older insured.

Why can’t children do the same thing as corporate investors?

The answer is they can but most do not think about doing this as a way to create their own retirement nest egg.

Let me just give you an example, which should drive home the point.

Let’s say you have a parent who is 70 years old and can allocate $20,000 a year after-tax to an “investment.”

Because children have an insurable interest on their parents, there is no issue with taking the $20,000 a year and purchasing a life insurance policy on one of your parents.

If you allocate $20,000 towards a premium every year on a policy on your 70 year old dad’s life, you may be able to purchase a policy with a $650,000 death benefit.

If dad dies when he’s supposed to (age 85), you would earn a $650,000 income and capital gains tax free benefit to be used for your retirement income.

The finances are really the key.

If you took $20,000 and invested it in the stock market you would be at risk to lose some or even most of that money in a market downturn (like from 1998-2000).

In the stock market you have capital gains taxes, dividend taxes, money management fees, etc. to deal with as your money grows.

If the $20,000 a year grew at 7.5% (net) you would have a $625,161 in your account.

However, if you took into account typical taxes, transaction fees and money management fees, you’d probably net more like 4.25% annually which would leave you with a $464,260 account balance when dad reaches age 85.

The question is would you like a guaranteed payout (a known death benefit) that will pay tax free at some point in time or is it better to have money at risk in the stock market?

For many, when they run the numbers, it will be clear that buying life insurance on a parent is, in fact, a very good and secure investment.

What if dad lives a long time?

That’s a double edge sword. It’s good because he’s still around to see and play with the grandkids. But it’s bad from a financial standpoint.

If dad lived until 90 or 95, you’d get paid the same death benefit tax-free.

The following would be the account balances in your brokerage account at the same ages assuming a 7.5% and a more realistic 4.25% net rate of return.

	7.5%	4.5%
90	$897,499	$571,664
95	$1,288,476	$703,917

Summary

The bottom line is that billions of dollars are invested every year by corporate buyers who purchase policies of elderly clients. They do it for one simple reason; the financial tax-free return is significant.

Is this concept a good way for you to build a retirement nest egg for yourself? I couldn’t say without knowing the specifics of your situation, but I will state with confidence that for many people who have elderly parents, buying a life insurance policy on them can be a terrific way to build wealth in a very tax-favorable manner.

Until next week,

Roccy M. DeFrancesco, JD,CWPP, CAPP, MMB

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