Section 79 plans may not be the wisest decision even though many small business owners would like to benefit from the 20-40% tax deduction salesmen are touting. We look at why the Section 79 gives lesser returns than other retirement plans and thus even with the tax deduction, they don’t make good financial sense. The following article discusses the disadvantages to using a Section 79 Plan.
Section 79 and Life Insurance Planning
Definition of Section 79 Plan: The Section 79 plans can be used by small business owners for asset protection and tax deductions. The plan will allow the owner to receive between 20% and 40% for a business deduction. This deduction will be applicable if the business owner purchases a CLV, also known as a cash value life insurance policy, and this policy must be individually owned.
When hearing what a Section 79 Plan is, many business owners may be eager to jump onboard and get one of these plans for asset protection and tax minimization if they are not sold in full disclosure. Since this is a tax-deductible way of getting a cash value life insurance policy, it sounds appealing. By itself, the cash value life insurance is a great retirement plan, but business owners should take a step back before making any hasty decisions and take a close look at the financial numbers. This will reveal that the Section 79 plans may not be as great as they first sound for asset protection and tax minimization.
Less than 10 Employees? Use Group Underwriting
If a business owner has 10 employees or less, laws restrict eligibility for any policy that has full medical underwriting. Instead, group underwriting will be required. Many insurance companies do not like group underwriting because these policies are more of a risk. When the math is revealed you will understand the reason these plans should be avoided for asset protection and tax minimization.
Section 79 Plans Disadvantages
The reason the Section 79 plans are so marginal is because the insurance policy that is being purchased, by nature and inheritance, is set up poorly to get the full deduction. In other words, the types of cash value life insurance policies resulting from the Section 79 do not return a lot of money in retirement. It would be more beneficial for the business owner to take a smaller deduction and have a better cash value life insurance policy. With a quality CVL (i.e. Cash Value Life), the business owner would receive a deduction of only between 5 and 8% which hardly makes economic sense. So how does a quality Cash Value Life policy compare with the Section 79 returns in retirement? Please read on.
Section 79 Results: After Five Years Convert to a EUIL or Variable Life Policy
After five years, clients will have the option to convert the Section 79 Plan into a better policy, such as an EIUL (Equity Indexed Universal Life) or variable life policy. These life policies can earn around 9% each year. However, even with the presumption that the rate of return will be 9%, the retirement returns are comparatively less than the policies we use.
Life Insurance Agents Who Sell Section 79 plans
Why do life insurance agents push Section 79 Plans without full disclosure? Agents have two reasons for pushing these plans. Firstly, business owners hate paying taxes and are attracted to the tax deductions with the Section 79. Secondly, advisors want to make a sale. Most probably really do not care about the well being of the business owner as long as a sale is made or the life insurance agents have not scrutinized the return of investments of other retirement strategies.
Business owners need to be informed so they can make educated decisions regarding these plans. From a financial standpoint, these plans do not provide much in terms of financial benefits, asset protection, or wealth building for retirement. In many cases, an agent will suggest these plans because they know the owner is looking for tax deductions. However, this does not mean that the plans themselves are overly beneficial – there are better ways to get tax deductions. Life insurance agents will seldom take the time to crunch the numbers and present the true breakdown to a client. Life insurance agents should be comparing the Section 79 plans with other policies.
This is why business owners have to be aware of what they are buying into. Instead of getting involved with a Section 79 plan, most small business owners would reap more benefits from paying the business income taxes and then funding a good EIUL (Equity Indexed Universal Life) to generate wealth in retirement.
Section 79 with good tax deduction vs. After-tax purchase of a Quality Cash Value Life
Let’s compare the returns of a Section 79 which has an initial good tax deduction with investments of funds of after-tax income into a good life policy. A proprietor buys $150,000 in premiums to a Section 79 Plan and he is 45 years of age and will be paying the premium for a period of five years. The proprietor will then borrow money from the life policy when he is between the ages of 65 and 84. We will compare this scenario with another option, which is for the proprietor to pay the taxes and use money to fund a good cash value life policy for a period of five years. The proprietor will then borrow from the life policy from ages 65 to 84.
Section 79 loaned money that is tax free annually = $125,469
Quality policy loaned money annually = $187,626
Is the difference in the amounts actually worth the 40% deduction for the Section 79 Plan? Of course not. It would actually be a very poor choice on behalf of the business owner if he decided to use a Section 79 plan after seeing the math.
To see a breakdown of the financial calculations of the Section 79 plan, please Section 79 income.
Pro or Con? Section 79
Agents will try to convince business owners into using a Section 79 Plan by focusing on the deduction. Unfortunately, many business owners will not look into these plans and calculate the numbers before they jump right in. Keep in mind that life insurance advisors are incentivized to make money, which means they want to sell insurance. They really must have not calculated the numbers or do not care if these plans are the right or wrong path for the owner. This is why it is essential for business owners to be aware of these plans and ask for full disclosure from the advisor before making any decision.
Contact Estate Street Partners to discuss how we can help you plan for retirement and what is the best investment to maximize your retirement income.
Read Part 2 on: Section 79 Insurance