Capitol City Banking Advisers Weblog

Buying term insurance and investing the difference vs buying permanent insurance

By Eric Steffensen

A recent article posted on CNN.com by the Armchair Millionaire addresses the ongoing debate over which strategy is best to cover your life insurance needs if you live beyond the maximum term duration that is available to you. The two main strategies that are used by financial planners to cover long term life insurance needs are 1) purchasing term insurance and investing “the difference” or purchasing a permanent life insurance policy.

Many consumer advocates in recent years have come out in favor of buying term and investing the difference. The life insurance industry has almost always argued in favor of buying permanent life insurance. Admittedly, most people will be more inclined to trust a consumer advocate over an insurance company; however, since insurance needs vary on a case by case basis, it may be prudent to explore both options to see which one is the best for your situation. Most financial planners should be able to provide you with a comparison between the two options that show what your beneficiaries would receive at your death. In many cases it may be possible to have the comparison show a periodic investment, using reasonable assumptions, that projects enough growth in your investment to cover your insurance benefit by the end of the term policy. To be fair, however, it is important to make sure that a few issues have been addressed in your comparison: taxation, investment suitability, liquidity, insurance plan design, discipline and the quality of your assumptions.

Taxation

Life insurance and investment vehicles are treated differently for tax purposes. As a general rule, life insurance death benefits are not subject to federal income or capital gains taxes if the insurance is set up correctly. Different investment vehicles are taxed differently, but as a general rule (with the exception of certain tax favored investments), the gain in your investment will be subject to some tax consequences. Your comparison should take into account the after tax effects of both strategies. To determine the ultimate tax consequences of your insurance or your investments, consult a qualified tax advisor.

Investment Suitability

Qualified investment advisers are required by their regulatory agencies, the NASD and the SEC to do an assessment of your “risk tolerance”. This is a measurement of how much risk an investor is able to take on in their investment portfolio. The investment portfolio that you’re considering should be considered acceptable or “suitable” within the guidelines set by your investment adviser; it wouldn’t make sense to use a growth stock portfolio as your investment if you can’t tolerate the ups and downs of the stock market.

Liquidity

One of the features that can be favorable for cash value life insurance is the ability to pull money out of the contract on a tax favored basis, first by withdrawing premiums up to the amount you’ve put in, then by taking low interest loans which aren’t usually subject to current taxation. Taking these types of distributions are not without consequence, however. If interest continues to accumulate to the point that causes a life insurance policy to lapse, the tax consequences can be disastrous. Additionally, there may be situations where distributions cannot be taken from a life insurance policy on a favorable basis. Consult your tax advisor for more details.

If you choose the side investment strategy, you’re the liquidity of your investment can vary dramatically depending on the type of investment vehicle you choose. Individual stocks, bonds, real estate, mutual funds, and variable annuities all have different consequences if money is taken out.

Insurance Plan Design

The current variety of permanent insurance plans allows for quite a bit of flexibility when it comes to designing your policy. Some universal life plans can be designed so that the policy is contractually guaranteed to remain in-force as long as stated premiums are made. Other insurance plans, known as variable life insurance, will allow you to place similar investment strategies inside your insurance policy, allowing your investment to grow in a tax favored vehicle. Additionally, these plans can often be designed to increase your death benefit as the cash value inside these plans increases.

Discipline

When approaching a financial planning strategy, it is often considered good practice to plan for what might happen in a worst case scenario. In difficult financial times, it’s conceivable that contributions a side investment or to an insurance plan may become more of a burden. The contributor may be tempted to lessen or in some cases cease contributing to the plan. In my opinion, permanent insurance creates more of a forced discipline of continuing premium payments because the contributor may need to go through underwriting again if the policy lapses. Conversely, if contributions had to be discontinued for a long enough time period where the insurance would lapse, you’d be better off with the side investment strategy because there would likely still be money in the side investment if contributions had ceased.

The Quality of Your Assumptions

The assumptions that you use for the return on your investment and the internal interest rates and costs inside your insurance plan can vary the results of your comparison. The assumptions you’re using for taxation can also greatly influence the results. In order to have an accurate comparison, it’s important to make sure that the assumptions you’re using are reasonable.

For investment hypothetical quotes, NASD rules place maximum restrictions of using a 12% interest rate assumption. Many investment advisers won’t use assumptions above 8%, especially since the tech stock bubble burst in 2000. The NASD also requires that a 0% assumption be shown. Most equity investments do not offer a guarantee of any type of return, and it is possible that investors may experience a negative return. Some variable annuities are offering guaranteed returns, but they often require the investor to “annuitize” at a certain time. Ordinary universal life plans and whole life plans have minimum guaranteed interest rates and guaranteed maximum insurance costs that make a “worst case scenario” illustration possible that isn’t possible to show in an investment.

In conclusion, both strategies have their advantages. Either strategy can in theory suit the needs of someone whose needs are longer than term insurance can provide. However, as with any financial strategy, the best one for you will depend on your financial situation and goals. As was recently pointed out in a recent article published by the Motley Fool on the same subject, insist that your financial planner explains the differences between these two strategies to you on your own terms.

Eric Steffensen is the Director of Operations for Capitol City Advisory Group, Inc., an Atlanta based financial services firm offering insurance, investment and lending services direct to the general public in addition to offering back office support for these services for financial planners and investment advisers. Capitol City Advisory Group, Inc. offers securities through SIG Securities, LLC Member NASD and SIPC, 1501 LBJ Freeway, Ste. 220 Dallas, TX 75234 972-884-6123. Capitol City Advisory Group, Inc. is not owned or operated by SIG Securities.

Thoughts on Compliance

Today’s thoughts come from a company who had recently applied to the webring we manage, the Financial Services Blog Webring. Their site definitely appeared to be a financial services blog and therefore would qualify for the ring. However, they did not provide a correct hyperlink to their blog. In order to be helpful I decided to do a google search to see if I could find the correct hyperlink.

As it turns out, the Google search revealed that this company has been accused several times in several jurisdictions of trying to sell financial products without the proper licenses both in the United States and Internationally. All I could think of is that how poorly that reflected on the reputation of their company.

I’ve heard salespeople remark in the past about how they feel the compliance and licensing departments are enemies of sales departments. True, sometimes these functions make it more difficult to sell financial services…however there are many good reasons that these functions do exist in Financial Services companies. And unfortunately, when you ignore those functions altogether and attempt to sell without authorization,someone will get a hold of the story and tarnish your reputation. In a business where reputation is everything, I can’t imagine a bigger mistake.

What is a banking adviser?

I’m sure without fully understanding our business model that some people may be confused about the word “banking” in our company name…after all, we’re not a bank, we’re just an innovative financial services company. The name is appopriate because of one our primary business initiatives: to help local and community banks offer financial services that they’re not traditionally equipped to offer.

Larger commercial banks have started offering these services, which has the potential to attract customers away from the smaller banks. We believe that by offering these services, local and community banks will retain their existing clients and attract new clients. Additionally, some of the services we’re offering to local and community banks are designed to increase their deposits, which in turn helps raise their lending limits. Of course, getting past the board of directors at a community bank can be a challenge; however we have a unique approach that will stand up to extreme scrutiny.

We’re currently looking for a few motivated salespeople to bring our intiative into community banks. Ideal candidates either have experience either in the banking industry or as a financial adviser. If you’re interested in this opportunity, please visit our homepage and click on the career opportunities button. Complete the form, attach your resume, and we will be in touch.

Mortgage term life insurance

I’ve run across a couple of blogs today that the owners had recently discovered term life insurance where there is no medical exam required. The main qualification for these policies is that the proposed insured has taken out a new mortgage (either a purchase or a refinance) within the past two years. This type of insurance can be applied for over the internet without ever consulting an insurance agent. The authors of these blogs were correct in their assesment that this type of coverage is very appealing to people who have medical conditions that may keep them from qualifying for the best rates, or for those that prefer the convenience of applying for insurance this way.

The only thing I’d like to add to their assesment is that Guarantee Trust Life is NOT the only insurance company offering such a plan. I’ve uncovered three others: Jefferson National, North American and United of Omaha. If you’re concerned about financial stability of your insurance company, its important to note that both United of Omaha and North American have much better financial ratings from the major rating services than either Jefferson National or Guarantee Trust. GTL is the only company that I know of that allows the client to apply directly over the internet, however.

I’m going to search for a website that compares these type of term policies so that consumers can make sure they’re getting the best deal. And if such a website doesn’t exist yet, I may just have to build it.

Developing a Financial Planning Practice

“Financial Planner” and “Financial Adviser” are among the most ambiguous titles that are used when describing a carrer. These terms can vary in meaning from insurance agent to stockbroker to Certified Financial Planner to CPA to a tax attorney (and anywhere inbetween). Contrary to what some of the MLM organizations (otherwise known as WMA and Primerica) have been claiming for years, being a financial adviser is not for everyone. A successful financial planner will not only have great analytical skills, but will have great sales, people, and communications skills and a strong ethical compass. Combine those skills with persistence and a strong desire to help people and chances are you will succeed in this field.

If I haven’t weeded you out with those requirements and you’re still interested in becoming a financial planner, here are some tips that can get you started down the yellow brick road, or at least back on track.

Find a mentor
Financial Planning is one of the few remaining careers that don’t require a college education to do well in. While a business or a finance degree can be extremely valuable, I believe the best way to learn this business is to study someone else who is already successful. A good mentor will be able to explain the tools of the trade but will also teach you how to prospect and how to build referral sources. A good way to find a mentor may be to start as a captive agent for an insurance company as some of these companies have excellent training programs. If you take this route, I would suggest choosing a company that focuses on high net worth clients as the training programs are usually better. Eventually you may consider switching away from a captive environment to a platform where you can offer financial products from different providers in an unbiased way. Even though the personal presentation and the financial strategies you choose for your clients will prove to be more valuable than product, many of your clients will appreciate the fact that you are willing to go the extra mile to find the best product available for them, therefore making the most efficient use of your clients’ money.

Continuing Education
Having a designation (letters after your name) isn’t necessary, mostly because the general public won’t always know what the designation means. However, there are certain designations that are worth pursuing, mostly because the value of the education you receive while pursing the designation is high. A list of recognized designations can be found here. Place a high value on any education that teaches tax code, as understanding the tax implications of financial products you recommend is vital, even if you need to refer your clients to a tax adviser.

Build referral sources
In the high net worth arena, many advisers focus on building relationships with established attorneys and CPAs in order to bring referrals. This is a powerful way of finding referrals because often these professionals and their advice are highly regarded by their clients. If these professionals see that you are thorough in developing financial plans and make appropriate recommendations, they are more likely to send you business. There are several ways of building these referral sources including direct mail marketing, holding seminars, attending networking functions, telephone campaigns, but by far the best is through word of mouth.

Specialize
Once you’ve learned the ropes, it’s a good idea to specialize your practice to either the type of planning you do, the types of products you offer, to your defined target market, or to all of the above. Some of the most successful financial advisers have focused both the type of planning they offer and their target market, for example offering only estate planning to retired GM employees. The more specialized your practice is, the less time you will need to spend keeping up with changes to the industry or to changes in your target demographic, which gives you more time to prospect, build referral sources, focus on branding, and do actual financial planning for your clients.

Create a recognizable brand
At the individual producer level, the financial services industry as a whole is guilty of putting out some of the ugliest marketing materials ever created. While content is always king, materials that are attractively designed are likely to draw more readers in. Unless you have experience and talent for design, it may be a good idea to hire a professional graphic designer or a branding coach to help develop your image. Remember however, that branding is much more than marketing materials, it also is the reputation you earn for continuing to give your clients extraordinary service and quality financial advice.

Low student loan and consolidation rates can’t last

A recent column on the Wall Street Journal opinion page highlight’s the “culture of dependency” created by the current student loan program. It also mentions a bill that would require student loans and consolidation loans to use a variable interest rate (rather than a fixed rate) along with other education funding reforms. While such a bill would be unpopular with parents and students, the federal government’s need to cut subsidies across the board may force this bill or a similar bill to pass in the near future.

Normally, we here at Capitol City Banking Advisers don’t resort to “fire sale” tactics to market our products or services. The financial planning strategies we normally choose to promote are generally considered conservative and proven. However, there are certain situations where we recommend action in a timely manner if it is truly beneficial to our clients.

It’s possible that student loan consolidation may still be a financial strategy that makes sense even after such legislation is enacted; however by paying attention to the current climate in Washington, we believe that putting off student loan consolidation could be a mistake. Start the process now.

Eric

Today in the blogosphere…

… I came across an interesting Blog Entry from a college student who is frustrated by the Student Loan Consolidation game. He goes on to note that he can’t trust any of the banks or lenders that he’s getting letters from to consolidate, because they’re trying to sell him something. He further distrusts his Financial Aid office since they are more likely to side with the banks than with pure objectivism.

I can understand how trusting an institution that sends you unsolicited offers can be a difficult task. I can understand that since there are so many companies that offer student loan consolidation, that it’s easy to wonder if you’re getting the best deal. I’ve always felt that with financial products, that it’s easier to buy from someone you know and trust, and student loans are no different. But for the most part, as it is now, student loans and consolidation only seem to be available from people you don’t know.

As it is, most people probably can buy a mortgage, or insurance, or even investment products from a friend or a trusted advisor. We have an initiative to start distributing student loans through financial advisers and community banks (who rarely offer student loans). Maybe, if our initiative succeeds, you will be able to one day get student loan consolidation from someone you know.

Eric

Making life insurance exciting

I’m sure this challenge has perplexed the marketing geniuses at some of the larger insurance companies for decades. Why? Because life insurance is one of those things that most people, even people who make a living selling it, can’t really get all that excited about. The way I see it, even though they’re both inevitable, death and taxes aren’t subjects that appeal to mainstream America.

Take ING’s televison commercials for example: there’s almost nothing they can really (or legally) say to excite the viewer about their products, so they make it a point to let the viewer know they offer life insurance, annuities, and a host of other financial products, and leave them with an image of a bizarre happening in the park. In fact, the life insurance industry has produced some of the most dry and boring marketing in the history of all marketing. There have been some notable exceptions (anyone remember Mutual of Omaha’s Wild Kingdom?) but for the most part it is just not a product that can be as exciting as a sportscar, or a new flavor of soda.

Although we here at Capitol City Banking Advisers are committed to putting a fresh face on the industry, we have not yet devised a solution to this age old dillema. However, we can help people who are paying too much for their insurance to save money (and we can help agents pass along these same savings to their clients). And that’s got to at least excite a few people.

Eric

Financial Aid Deadlines (courtesy of NextStudent)

Jan: Submit the FAFSA and search for scholarships

Feb: Complete any financial forms your school or state requires

Mar: Review your Student Aid Report carefully; make any necessary corrections

Apr: Watch for award letters

May: Choose the school you wish to attend and notify that school

Jun: Apply for Federal Stafford Loans and Federal PLUS Loans for Parents

Jul: Apply for a private loan if you need money to “fill the funding gap”

Aug: If you’ve been awarded work-study, contact your school’s Financial Aid Office

Sep: Apply for scholarships using the Scholarship Search Engine - search early and often

Oct: Continue to look for scholarships and grants; High school seniors-apply for early decision, if applicable

Nov: High school seniors - get letters of recommendation from friends, teachers and co-workers

Dec: Complete the FAFSA Pre-App Worksheet; Seniors - submit applications for admission to the colleges of your choice

Who stands behind your insurance agent?

Unless your insurance agent is a “captive” agent (represents only one company), chances are he or she uses a brokerage company to shop the market for the most favorable insurance policies for his or her clients. There are several of these brokerage companies, often called Master General Agencies (MGA) or Super General Agencies that act as the middleman between your insurance agent and the insurance companies.

Often the level of service you will receive from your agent will be tied to the level of service he or she receives from the MGA. As a general rule the larger MGAs have contracts with more insurance companies and are more likely to provide you with the most competetive policy. But also as a general rule, the larger the MGA, the longer it will take to process your policy through underwriting. Depending on which is more important to you, it may be a good idea to ask your broker about which MGA he or she uses, and then to research a little bit about the company. You may be surprised at what you find.

Eric Steffensen, Director of Operations
Capitol City Banking Advisers