The math behind the illustration from my
Section 79 Plan newsletter
Before I get into the math, I wanted to let you know that if you have profitable small business clients who want to deduct $100,000 - $1.2 million a year into a benefit plan, they should look at using a Captive Insurance Company (CIC).
CICs are not benefit plans, but they can be terrific wealth building tools. They provide needed insurance to the business for liabilities the business is self-insuring against now. If there is a good claims history, clients can remove money from their CIC at the long term capital gains tax rate or even tax-free if setup correctly.
Additionally, in my CIC structure it is financially prudent to use a high cash value EIUL policy as a way to grow wealth for reserves in the CIC while protecting the money from downturns in the stock market.
If you’d like to view a little PowerPoint presentation on CICs, please click on the following link:
If my newsletter has you wondering about Retirement Life™ , you can learn more about it by going to the following link:
Let me tell you more specifically how Section 79 Plan illustrations are run.
Typically the TPA that illustrates them will show a rate of return in the policy of 5.75%-6% the first five years and then some much higher number thereafter like 8-9.4%.
It’s tough to do that with traditional life insurance software so I had to come up with what I thought was a fair example using traditional software for the Revolutionary Life comparison.
So, for the Section 79 Plan illustration, I assumed a 6% rate or return the first five years and an 8% return thereafter.
With the Revolutionary Life illustration, I assumed a 7.5% rate of return throughout the life of the policy. So, for the first five years the return was 1.5% higher, but for years 6-40+ the Section 79 Plan policy had a .5% higher rate of return.
This is not a fair comparison to the Revolutionary Life policy because having .5% higher as a rate of return for 35+ years will be much more advantageous than having a 1.5% higher rate the first five years, but I wanted to create a “conservative” example that would favor the Section 79 Plan policy.
I knew as it turned out that with the numbers slanted in the Section 79 Plan policy that Revolutionary Life would still be a much better wealth accumulating tool.
FYI, I also assumed wash loans with both policies.
Remember the example.
The company contributes $100,000 a year into a Section 79 Plan policy for five years. The policy is owned by the business owner and the imputed income to the employee is approximately $60,000 a year (40% deductible).
However, because the employee didn’t get the $100,000 and has a tax bill based on $60,000 of income, he has to come up with $24,000 after-tax to pay the income tax bill. ($60,000 if imputed income in the 40% tax bracket costs $24,000 a year in taxes).
What would the owner have available to fund a “good” cash value policy if he did not implement a Section 79 plan?
The owner would have taken his $100,000 income home and paid $40,000 in taxes leaving $60,000, AND he would have the $24,000 that he would have had to use to pay income taxes on the imputed income as he did with the Section 79 Plan.
In other words, because I’m trying to run an apples to apples comparison, I need to take the $60,000 of left over income he took home from his $100,000 of income and add that to the $24,000 of taxes he would have had to pay if he implemented the Section 79 Plan.
$60,000 + $24,000 = $84,000 available to fund every year for five years into a Revolutionary Life policy.
The following numbers will compare $100,000 going into a Section 79 Plan EIUL policy vs. $84,000 going into a “good” EIUL policy.
How much could be removed from the Section 79 Plan policy tax-free in retirement from ages 66-85?
How much could be removed from the “good” EIUL policy tax-free in retirement from ages 66-85?
The bottom line is that Section 79 Plans are extremely marginal from a wealth building standpoint and are mainly sold by advisors who do not understand the math or do understand the math and don’t care because the plans help them push/sell life insurance.
The math is clear that building wealth through cash value life insurance policies can work very well (I have a terrific chapter in my book Retiring Without Risk where I illustrate how cash value life can work out better than using a tax-deferred 401(k) plan or investing in stocks after-tax).
However, manipulating a client to use a Section 79 Plan that is so very marginal from a wealth building standpoint because it is sexy to sell a 40% deductible plan is not the right path to go down for advisors who want to do the “right thing” for their clients.
You have the math and you can make your decisions accordingly.