I wrote about this concept last year, but I have met several people recently who were complaining about the low yields on their savings, so I think it is appropriate to revisit it. A Google search of “best CD rates in NJ” returned the following: 1 year, 1.13%; 2 year, 1.33%; 5 year, 1.85%. So yeah, the complaints are legitimate.
The concept involves pairing a life insurance policy with a single premium immediate annuity (SPIA). The person must be insurable, and while it will work with any age, I think it is appropriate for those over 60. In this example, I will use a male age 65 in good health (second best underwriting class) and $250,000 in a low yielding CD.
First, the money in the CD is repositioned into a life only SPIA (While the concept will work with a cash refund or term certain SPIA, the best results are obtained using life only). This will generate $1,396.43/month, of which $1,041.74 is income tax free until the entire principal ($250,000) is recovered, after which time the entire $1.396.43 would be taxable. $1,396.43/month x 12 months equals $16,757.16/year, which equates to a 6.7% annual return ($16,757/$250,000 = 6.7%).
The major drawback of a life only annuity is that the payments stop when the annuitant dies, be that in year one or year 40. To hedge against an early death, a $250,000 life insurance policy should be procured, thus ensuring that the principal remains intact.
A $250,000 policy guaranteed to age 120 carries an annual premium of $5,749, which, when offset against the annuity income, would produce an annual yield of 4.4% ($16,757 - $5,749 = $11,008, divided by the $250,000 = 4.4%). In reality, the yield is higher in the early years due to the tax free return of premium included in the payment.
Reducing the guarantee on life insurance policy from age 120 to age 100 or 95 would increase the total yield (as the life insurance premium would be lower), albeit not without some degree of risk.
As if this wasn’t good enough, there is another potential benefit to this concept. The value of the SPIA at death is zero, since payments cease at the death of the annuitant. So what was includible in his estate as $250,000 (the CD) is now zero. If estate taxes are an issue (and it only takes $675,000 in New Jersey to trigger the estate tax), then the life insurance should be owned by a trust, thus keeping those proceeds out of the estate.
A New Jersey estate valued at $2,000,000 is subject to an estate tax of $103,920. A New Jersey estate valued at $1,750,000 is subject to an estate tax of $85,920, thus saving $18,000 in taxes. The larger the estate, the larger the tax savings.
While clearly not a panacea, given the right situation, this strategy is extremely effective.
This is only intended as a general introduction to the concept. All the standard disclaimers apply. If you would like more specific information, please call or email.