New tax laws, new tax-free life insurance

Life insurance salesmen used to be the Rodney Dangerfields of the financial world: They had trouble getting respect. Well, if he were in the insurance business now, ol' Rodney would have to find a new comedy routine. Thanks to tax reform, the life insurance industry is making the most of an arsenal of tax-free investing and saving products, while other tax-advantaged vehicles, like individual retirement accounts (IRAs), have been severely restricted.

The boost from tax reform has insurance companies flexing their marketing muscle to sell as many tax-advantaged annuities and life insurance policies as they can - while they still have the new tax laws working for them.

For consumers, these policies could be an excellent way to build up tax-deferred savings for retirement or college and provide insurance protection for the family.

Or they could be an expensive proposition with hefty sales charges, early-withdawal penalties, poor-performing investments, or the loss of money if the insurance company goes under.

Which side of this equation you land on will depend on your age, your insurance and income needs now and during retirement, and the strength of the company pitching the product. All should be carefully considered before signing any checks.

For the life insurance industry, hit by falling sales of whole life policies and having to make do with less profitable term insurance, tax reform came just in time. Now, policies that were only moderate sellers - particularly universal life and single-premium whole life - are expected to get some hefty help.

``They make a lot of sense to me,'' says William Freund, a vice-president and financial planner with Prescott, Ball & Turben, a Cleveland brokerage. ``It looks like one of the relatively few tax shelters one has left.'' They can, for instance, be attractive to people in their early to mid-50s who want to transfer an IRA or lump-sum pension payment into an insurance product that will provide income at retirement.

Both universal life, or universal-variable life, and single-premium whole life insurance let a policyholder move money into and among a variety of investment alternatives, typically a stock fund, a bond fund, and a money-market fund. As long as the tranfers stay within this menu and within the insurance company, all transfers and gains are tax-free.

This is similar to what people have been doing with IRAs, although IRAs also permitted tax-free transfers between companies. Now, with the full deduction limited to single people with adjusted gross incomes under $35,000 and married couples under $50,000, people are looking for other ways to shelter retirement savings.

Single-premium insurance may also appeal to parents saving for their children's college. They can buy a policy and let the interest build up tax-deferred until the child reaches college age. Then they can borrow the interest from the policy. Meanwhile, they also have additional life insurance.

The most heavily touted product right now is the single-premium whole life policy. With this, you make an initial lump-sum payment, usually $5,000, and you can make subsequent payments of at least $30 to $50. Initial premiums can go as high as $1 million. Because all earnings are tax-free and because you start with more money, the policy grows faster than if it were funded with smaller annual premiums.

As long as you need some additional life insurance, these policies could make sense. But if you plan to use them primarily as tax shelters - which is how some companies are promoting them - they may spell trouble. For one thing, getting out of the insurance contract early can be expensive. And all this promotion is being watched by the Treasury Department and Congress, which could make these policies the next target of efforts to trim the budget deficit. Any action on this front would make insurance less useful as a long-range planning tool.

``Congress has few alternatives left,'' notes A.Scott Logan, president of Wood-Logan Associates, a Greenwich, Conn., distributor of fixed and variable annuities. ``They could go after municipal bonds, but once they've done that, insurance is all that's left. When you have the climate we have, from a budgetary and financial standpoint, they will always be looking for additional revenues.''

``One hopes any new regulations would grandfather the old,'' that is, permit already written policies to continue operating as originally designed, says Bruce Dayton, a financial planner in Weston, Mass. But grandfathering doesn't always happen. It didn't happen, for instance, with tax shelters, where investments made before Oct. 23 of this year will gradually lose their passive losses for tax purposes.

In the past, aggressive marketing has led to other problems - such as at Baldwin-United. It's been only three years since six of that company's insurance subsidiaries went bankrupt. To keep and attract business, they were quoting and paying yields that exceeded the performance of their own investments.

If you don't need the insurance but still want to do some tax-assisted savings, an annuity may be preferable to single-premium whole life. Fixed annuities currently guarantee a first-year yield of about 8 percent; after that the rate drops to 4 or 5 percent.

Variable annuities offer a variety of investment options whereby a customer can make tax-free switches. With a variable annuity, however, success largely depends on the policyholder's ability to make timely and proper investment decisions.

Apart from future tax considerations, all of these products should be examined carefully on a number of points.

Loads and fees. Many policies are available with no front-end charges, so you should be able to avoid them. But most also carry early-withdrawal penalties that expire after five or six years, so plan on staying with them for at least that long. Also, beginning next year, people who pull out of deferred annuities before age 59 will face a 10 percent penalty. This is one of the few areas where tax reform affected life insurance products.

Your principal, again. If you do need to make an early withdrawal from a whole-life policy or annuity, what are the charges or penalties, even after the five- or six-year early-withdrawal period?

The strength of the company. While even the best insurance company might have problems, there are plenty of them with the strength to stand behind all their policies. A company should carry at least an A or A+ grade from A.M.Best's, the insurance rating firm. Most public libraries will have a recent copy of Best's directory.

A physical. Depending on your age, you may have to pass a physical examination to get the whole-life policy.

Interest rate guarantees. Some companies quote a very attractive yield on fixed policies, but they don't do a good job after the guarantee period. Carefully compare the companies' track records in paying yields that keep up with the current interest rate environment.

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