Saturday, December 11, 2010

Ways to lower your estate taxes

Hello everyone. I am sick and tired of people recommending cash value life insurance as a way to pay estate taxes. Cash value life insurance are ripoffs and have no purpose. I've been in financial services for many years now and if you are worried about estate taxes when you die, then here are some ways to lower or eliminate your estate taxes on your own. I am not an estate planner, but someone who is very knowledgeable about many different financial products. If you want to use an estate planner and pay money, then that's up to you.

You may be able to invest in your state municipal mutual fund and you won't pay any income taxes at all. Not all states offer tax-exempt municipal mutual funds. So it is important to check with your state if municipal bonds are exempt from income taxes. Almost every investment company offer municipal mutual funds in every state. How they work is that these mutual funds invest only in muncipal bonds, which is offered by state, city, or local governments. They are low risk and you can withdraw money any time. They don't provide high returns, but they do pay monthly dividends or interest. The only big problem with municipal mutual funds is that they have high annual operating expenses, which reduces the rate of return on your investment.

Life insurance can also cover estate taxes if you die. I highly recommend setting up an Irrevocable Life Insurance Trust (ILIT). You will need an attorney to help set this up. An ILIT offers the opportunity of escaping taxes not just in one estate, but in several estates. The ILIT is typically a trust for the benefit of the spouse and/or children. I suggest getting a level term insurance policy from Primerica. I don't know your age, but if you are 70 years old or younger, you can get a 10 year to 20 year level term. Primerica offers the lowest renewal rates on term policies in the entire life insurance industry (as of 2010). When you are applying for life insurance, make the ILIT the owner and beneficiary of the policy. You will lose your right to make changes to the policy (such as getting more coverage or changing beneficiaries). You must make an annual tax-exempt gift to the ILIT so that the ILIT can pay the premiums every year. If the premiums become too expensive, you can let the policy lapse by not putting any money into the ILIT. Don't forget, you can withdraw money from your state municipal mutual fund.

You can rollover a 401k or Traditional IRA into a Roth IRA. You will owe income taxes upon the conversion. Money can grow in a Roth IRA forever and you pass it on to your heirs tax free. If you are currently working, you can contribute up to $5000 (if you are 49 yrs old or younger) or $6000 (if you are 50 yrs old or older) every year into your Roth IRA. If you earn less than $5000 or $6000 per year, then you can 100% of whatever income you earn from your job. For example, if you only earn $4000 for the year, then you can only put in a maximum $4000, not $5000 or $6000 (*Please note that your contribution limits into IRA may change in the future. Consult with IRS website and search for Publication 590).

Open a 529 plan. You can make a tax-free gift contribution of up to $13,000/year (don't forget about the contributions you made to the ILIT if you set that up). You can name anyone as the beneficiary (hopefully you name your child or grand child as beneficiary). You have full ownership of the plan. If you have financial hardship, you can take money out, but you will pay a 10% penalty and income taxes on the earnings.

You should also consider setting up a Will to make sure who in your family gets what ever belongs to you from personal belongings, house, cars, to all your assets and investments. I remember there was one family where 2 sisters fought over silver forks and other silver ware when their dad died. They went to court over silver forks. Its ridiculous, but its true. You should get a Will through Prepaid Legal. It cost about $20/month and the Will is done for free. After you get the Will and setup the ILIT, its up to you if you want to keep Prepaid Legal.

Sunday, December 05, 2010

Children life insurance

I am totally against any children life insurance since there is no reason to buy a life insurance policy on children. If you think you need to get life insurance on your children for whatever reason, then add a child rider to your current life insurance policy. If you don't have a life insurance policy and you are a parent, then why are you getting life insurance on your children first and you don't have one for yourself? Life insurance's purpose is to replace the breadwinner's income in the event they may die. What income does a 5 year old bring to the family? NOTHING!

I recently saw a TV ad from Gerber Life Insurance about Gerber Grow-Up plan. They advertise as if its a great savings plan for college. They don't say its a savings plan, but instead they said "With $10,000, that money double to $20,000 when your child becomes 18 years old at NO EXTRA COST." That money is the death benefit. Then they go on to say, "Your child can get 10 times the coverage of up to $100,000." It then ends in a quick ending, "Your child may borrow from the cash value."

Let me break it down on how this Gerber Grow-Up plan really works:

Basically its a whole life policy where your premiums are paid for two things: The insurance and the cash value. While premiums may seem very low (about $216/year for $25,000 coverage), a 35 year old man that is healthy can purchase a 20 year term policy with $250,000 for about the same price! In the first 2 years of the policy, no cash value is accumulated. After that, you will get 1 to 3% interest on the cash value. I'm not sure how they determine how much of your premiums goes into the cash value. At age 18, the coverage doubles and premiums stay the same. So that means you were paying lots of premiums before the coverage doubled. When your child reach age 21, ownership of the policy is transferred from you to your child and your child can get ten times the coverage.

If you (or your child at age 21 or older) wanted take money out of the policy, you can borrow from the cash value. You will be charged 8% annual interest. When you pay this loan back, the interest goes to the insurance company. It's similar to you withdrawing money from your savings account, but the bank giong to charge you daily interest until you put the money back. If you or your child cancels the policy while there's a loan balance due, you will be responsible for income tax on the loan balance if the child is under 21. If the child is 21 years old or older, your child will be responsible for income tax on the loan balance. Surrender charge will apply on the cash value if you or your child cancels the policy. If the child dies and there is a loan balance, this amount plus interest plus missed premiums will be deducted from the face amount of the policy. All the cash value is kept by the insurance company.

In summary:
1) Its very expensive.
2) It gets a very low rate of return
3) No withdrawals allowed. You either borrow and pay 8% interest OR cancel the policy and pay surrender charges.
4) Lose cash value upon death of the child, but at least they pay the death benefit to you.
5) One policy per child

My recommendation:
Get a term policy on yourself. Most people only need 20 years. Some need 10 or 30 years. Financial experts say you should get coverage of ten times of your gross income. But every situation is different, so I would go with a company that can find the exact amount of coverage you really need or determine the amount of coverage you need by yourself. A good start would add all your debts. If you have $300,000 in total debts, then you going to need at least $300,000 in coverage. A 35 year old who is healthy and gets a 20 year level term with $300,000 coverage will cost about $20 to $25 per month. I used to own a 20 year level term with $250,000 coverage at age 23 and pay about $18/month. I now own a 30 year level term with $500k coverage at age 30 and pay $475/year for it.

If you are married, add a spouse rider to your policy. If you really want to put coverage on your child, you can add a child rider with a minimum of $5000 coverage to a maximum of $25,000 coverage. A child rider covers all children from 14 days old to age 25. At age 25, the child can get his or her own life insurance, regardless of health status. By adding these riders, your entire family can be protected in one life insurance policy. If you were to get individual life insurance policy for each member of your household, it will cost you lots of money.

I don't know your other goals, but I'm guessing retirement and funding your child's higher education (college) are 2 of the things you want to accomplish. Its kind of impossible for me to tell how much you need to save every month to accomplish both these goals. But I can give you some pointers. For retirement, you want to open a Roth IRA. You want to invest in mutual funds because mutual funds has historically out-perform the stock market in the long run. I invest $400/month in 4 different mutual funds. If the average annual return on my investment is 10%, in 20 years I will have about $306,000 saved. I would be 43 years old and plan to retire at age 60. So at age 60, I will have about $1.8 million. I'm being conservative with 10% because the mutual funds I have done 14% average annual return from 1980 to 2009.

I don't have any kids, but if I did, I would open a 529 plan for my child to fund his or her higher education. There are other plans that can accomplish this goal such as Coverdell and UGMA/UTMA accounts. A Roth or Traditional IRA can even fund for your child's higher education, but I would only use an IRA for retirement.

Gerber Life Insurance also sells Gerber Life College Plan, another life insurance ripoff and should really be called Gerber Endowment Life Insurance. This is an endowment policy. How this works is that you select a coverage of up to $150,000 and you pay the agreed premiums. If you live through the term, the policy will pay you the coverage amount and you can use the money for whatever purpose. If you die during the term it will pay the coverage amount to your beneficiary. In endowment policies, the cash value grows very rapidly than a whole life policy and you will lose tax advantages. You will owe income taxes every year because the cash value will be greater than the face amount of the policy at age 95. Also death benefit will be taxable as well. Withdrawals of cash value before age 59 1/2 may result in income taxes and 10% penalty IF AND ONLY IF the cash value grows faster than a 7-pay whole life policy. Bottom line: THIS PRODUCT IS GARBAGE! Why pay so much money and income taxes to build a college fund for your kids in a life insurance policy when your money can grow tax-deferred in 529 plans?