The Modified Endowment Contract

April 29, 2010

A modified what? It’s called a Modified Endowment Contract (MEC) and was a creation of the terrible twins TAMRA (Technical And Miscellaneous Revenue Act of 1988) and DEFRA (Deficit Reduction Act of 1984).

It’s important you understand why the MEC was created, who created it, and how it can effect your money.  IRS Code, Title 26, Subtitle F, Chapter 79, Section 7720 is the description.  If you’re bored feel free to read it. Here’s the point.  The very fact they, the government, made the effort to craft and pass this type of restriction and limitation on what you could do with your money, keep in mind, it wasn’t like this prior to 1988, tells us one thing: it must be good in regards to taxation.

You see, prior to 1988 you could put virtually an unlimited amount of money into cash value life insurance and get all the benefits.  What benefits?  Here’s a list:

  • money grows tax deferred,
  • can be used tax free,
  • has a competitve rate-of-return (remember no fees and no tax),
  • has guarantees,
  • returns a tax-free dividend based upon company performance,
  • the money is credit proof,
  • you could contribute an unlimited amount of money,
  • you were unlimited in your investment options because you had
  • liquidity, use and control of the money,
  • it could be used as collateral,
  • it was estate tax-free, and
  • had disability protection – meaning if you became disabled the insurance company would continue to contribute your annual outlay (what 401k will do that one?).

Take a look at this pdf and line up the benefits you have with your money compared to how these policies are designed…click here.

The government didn’t like this; therefore, they decided to “further limit the perceived abuses by preventing policyholders from paying large single premiums to purchase life insurance and borrowing the cash value, tax-free.”  Heaven forbid we have some financial tools that they don’t have their hands ALL over.  The founding fathers of this country would be up-in-arms.  Folks, this type of policy, and the benefits associated with it, had been a LONG standing tool used by virtually all the wealthy families in the country…here’s a great book that describes this very thing, The Pirates of Manhattan.  I have no association with this book it’s just a good read.  Check this out, this is an article from November of 1999 in the Denver Business Journal.  They did a special publication called The Century Book. This publication dedicated one page for every year from 1900 to 1999 and covered something from Denver’s history for each year.  For the 1929 page they talked about the Crash and introduced you to Claude Boettcher – “Denver’s most famous investor”.  Anyone who has lived in Colorado for any length of time has heard of the Boettcher family.  This article mentions how he lost everything but waited for banks and stocks to drop so low that he borrowed $2,000,000 from his cash value life insurance to buy them all up (notice he lost his investments but he didn’t lose his insurance values).  I love the line right after the mention of this – “the reason he is still known to history. Most investors had no other resources to call on.”  Read it here.  The “Infinite Banking Concept” is NOT NEW!  It has been around for over a century.

In 1988, the government created a limit.  So think about this: who determines the minimum one can pay for a death benefit of, let’s say $500,000?  Come on, who determines the minimum you, the consumer, can pay for a death benefit of half a million?  The insurance company.  They decide what they can charge you and still make a profit.  This is called term insurance.  You pay the least amount and get one benefit – death benefit.  On the other side of the spectrum, who determines the MOST you can pay for that same $500,000 death benefit?  Most people say, “I do. I determine the most I’m willing to pay.”  Wrong.  The government.  The very fact that the government limits what you are able to do with your money tells you that it must be good in regards to taxes.  You know what, they’re right.  Of course they’re right. Taxes are their biggest concern.  If they aren’t getting them then you bet your $SS they’ll go out and find them.

It then begs the question as to why whole life insurance policies are still around then, right?  Well, you can still get all the above benefits, EVERY one of them, you just have to now capitalize the policy a little slower.  Before 1988, you could put, for example, $200,000 as a lump sum into a policy and get all the benefits.  Today, you have to spread that out over, typically, a five to seven year period.  The argument of “cash value life insurance is too expensive” is plain elementary.  Those supposed experts who make that claim are right if someone is using CVLI purely for protection…i.e., focused on one benefit.  Buy term and do something with the rest.  However, if you want to act and function just like a bank then you’d pay the most amount of money for the smallest death benefit to dance just below the MEC line and get ALL the benefits above on your money.  Read that sentence again. Around year five you’d have available every single dollar you put in.  This then becomes a pool of money that you can use to replace any financing or lost opportunity for paying cash.  It’s exactly what banks do.  Take a look at this graph (it’s nothing fancy as I created it, but the data is straight from the FDIC website). I broke down the top five banks and their holdings in cash value life insurance, in the BILLIONS, and more importantly, how they have increased their holdings over the past few years.

JPMorgan Chase is the only one who’s values went down between 2008 and 2009; however, their loan balances went up by almost the exact same amount.  They very well likely utilized this powerful tool to borrow from.  We’ll know at the end of this year when we see their numbers.  Folks, these are the top five banks in the country making double digit percentage increases in their cash value holdings!  Why?  Because they are masters of liquidity, use and control, and leverage.  I ask you, are you?

You can be.  It’s my job to teach you.

Kelly O’Connor – kelly.oconnor@mtnfinancial.com

303.578.9708

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Cash Value life insurance is a horrible investment; however…

May 15, 2009

We’ve all heard it: Cash Value life insurance is a horrible investment.

Are you ready for this?  All those gurus and experts ARE RIGHT!

The problem, there’s a “however” that needs to be added to that claim.

It should read like this: Cash Value life insurance is a horrible investment; however, if it’s not used or designed for death protection and instead is designed to maximize the MEC (Modified Endowment Contract) rule, then there’s no better place to park money.

What?

Let’s take a look at what was possible prior to 1986 when the government realized that the wealthy individuals had a tool that was too good of a tax shelter…got to love the government.  Prior to 1986 NO ONE talked bad about life insurance.  Why?  Because you could put as much as you wanted, no limits, into a policy and the insurance company would underwrite you for a small amount.

For example: someone with a million dollars could put it into an insurance policy and the insurance company would underwrite them for maybe $100,000 in death benefit.  Why would the individual do this?  For many reasons: All the money in the policy was safe from lawsuits, litigation, and even IRS liens.  The money was totally liquid and they had available what they put in.  Let me say that again: this money was completely liquid and could be used at anytime with NO qualification necessary and NO IRS involvement. The money also had guaranteed growth.

Real life example: the Denver Business Journal in November of 1999 produced what they called “The Century Book”.  This special edition provided a 100 year history of Denver and highlighted something or someone for each year of the century.  When you come to the year 1929 the event covered was of course the Great Crash.  Also within that article was the story of one of Denver’s most wealthy individuals and at the time Denver’s best market player, Claude Boettcher.  The article says this:

“When he returned (he was traveling in the Soviet Union when the market crashed), he fired the messenger who brought him news of his financial ruin.  He had the courage to wait for stocks to drop more before he borrowed $2 million for his insurance policy and bought stocks and banks – the reason he is still known to history.”

How much death benefit do you think $2,000,000 in cash value would have to have?  Back then, very little.  Notice, when the market crashed he didn’t lose his cash value.  It’s guaranteed. It can’t be lost.  He was “financially ruined” but did that effect his ability to access his capital? Nope. What is the one factor that saved him financially? Having access to capital. If this tool was not in his portfolio then Claude would have been just another story of riches to rags.  But still to this day his wealth lives on here in Denver.  Now if he was Denver’s best market player why in the world did he have so much in cash value life insurance?  He was obviously one smart man.

In 1986, the government decided that it was not fair that the wealthy had such a great tax shelter tool and decided to create what is called the Modified Endowment Contract.  Basically, this rule added the risk to the insurance company by creating a minimum death benefit for the premium being paid to fund the policy.  If a policy owner goes over this MEC line then the majority of all tax advantages are wiped out.  The policy becomes a qualified plan with the IRS all over it…forever.  This new MEC rule limits what I can do with my own money…thanks Big Brother.

Let’s get back to the original MYTH.  Virtually all gurus and experts say that Cash Value life insurance is a bad investment.  Let’s first prove they’re right before we illustrate the proper use of the MEC line.

If I had a healthy, 30 year old client who was willing to fund a policy for $25,000 per year, how much insurance do you think that would buy?  Probably around $2,500,000 in death benefit.  Why would this be a bad choice?  For the exact reason Dave Ramsey and Suze Orman say:  your cash value sucks.  Now Dave says you have no cash value for three years…even with this type of policy he’s wrong; however, it would take 12 years of paying $25,000 each year before you’d have available in cash value what you put in.  Not a good option.  If you needed $2.5 million in death protection then buy term and invest the rest.

Here’s the “however”.  However, if the policy is NOT designed to maximize the death benefit and “dance” on the MEC line then what do we have?

Same example: this client is willing to fund a policy for $25,000 per year but we use it to purchase the LEAST amount of death benefit in order to have the most cash value available.  The death benefit is only $900,000 and he has over $17,000 available DAY ONE.  When he makes his year three payment of $25,000 his cash value grows by $29,000…already getting back more than he put in.  At the end of year four when year five’s premium is paid, his total cash value exceeds what he has paid into the policy…NOT twelve years.  Let me ask you this: if you save for five years to buy a car by using a money market at your bank (which is what Dave Ramsey recommends), how much would have in the account?  What you put in right?  Plus a very small amount of interest; however, the IRS takes their share of that every year.  If Dave Ramsey recommends this type of account for purchasing items how is a policy designed in this matter a bad thing?  Keep in mind, the IRS doesn’t get their share.  Shoot, you even have a growing death benefit just in case…at year five the death benefit is over $1.3 million.

Insurance people think we’re the stupidest insurance agents around.  Why?  Because we don’t get paid on the cash portion of the policy.  The commissions would be incredible if we did the first example but we aren’t here to sell expensive death benefit policies we’re here to teach individuals how to bank.  Our commissions are significantly reduced.  Why would an insurance agent turn someone down this path when they can attempt to sell a huge policy and make a ton of money?  We don’t consider ourselves insurance agents, we’re bankers.

So why would we want to fund a policy like this? My next post will be how to USE these funds to redirect debt or purchase vehicles, equipment, etc.  Over time, if you implement this concept, you will NEVER pay another dollar in interest to another entity, you will NEVER need to finance with a bank, and you will NEVER lose a dime.

Cash Value life insurance is a horrible investment; however, if it’s not used or designed for death protection and instead is designed to maximize the MEC (Modified Endowment Contract) line, then there’s no better place to park money.  You get back everything you put in, there is no risk of principle loss, there’s a guaranteed return plus a tax-free dividend, compounding growth, gains tax-deferred but can be used later in life tax-free, no government involvement (they already ruled on all this), creates an immediate tax-free estate, and most importantly, it’s liquid and you have complete use and control of the money (read that one again – what other tool, other than a bank account, can you claim this).

You can have everything you need and anything you want. Don’t use the bank, be the “Bank”. Do what the wealthy have done for ages.

Kelly O’Connor – kelly.oconnor@mtnfinancial.com

303.578.9708

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