I’m about to retire and have a large sum of money in a passbook savings account making very little interest. My financial advisor is suggesting I take out an insurance policy as a safe way to make more interest than I’m getting at the bank. The net interest I’d get is 2.3% per year. This is not great but is better than anything I could get at the bank, including CDs. His claim is that the money would be liquid because the policy he wants to sell me has no surrender charge and that when I want to withdraw money I could get any amount, including the full amount I put in, within two weeks at any time.
Under IRS rules, this policy is considered a Modified Endowment Contract and therefore is subject to restrictions that do not apply to an ordinary life insurance policy. The main restriction is that when I withdraw funds, the first to come out will be from any interest accrued and be immediately taxed as ordinary income.
I have the feeling my financial advisor will be making a significant commission if I buy this policy from him. But if this works the way he says it does and I’m making 2.3% and the money is truly liquid, do I care?
Has anyone had experience with purchasing such a policy and did it work out well for you? Or perhaps you’re an insurance broker and can suggest questions I should be asking about this policy.
Since this is seeking opinions and personal experiences, let’s move this to IMHO. The factual aspects of the question may still be answered there as well.
Moving thread from General Questions to In My Humble Opinion.
I don’t know much about your specific circumstances. However, there are VERY few circumstances where you want a MEC.
Speaking in general terms, an Indexed Universal Life (IUL) policy stands a good chance of being the better way to go. An IUL uses a stock market index as a measuring device. That way, you can receive some of the up-side potential of the market without actually being in the market.
Ding! Ding! Ding! And there’s why you can’t be sure.
First of all, insurance policies as investments are pretty much regarded as a terrible idea. Second, financial advisors that sell products are universally regarded as a terrible idea. Your guy isn’t a financial advisor at all–no matter what it says on his card–he’s a salesman.
My suggestion is to dump your advisor and start over with one that you pay by the hour (sometimes workplaces provide these as part of the retirement package, depending on your industry, so you might not even have to pay for it). You’ll get better advice than you will on the Internet.
So, all that being said, and realizing I’m not a financial advisor either: no way. You can beat 2.3% on the dividend return alone of some stable energy stocks, and if you find a low-cost value fund, you can do it without much risk, either.
The 2.3% rate they’re claiming you’ll get isn’t that great. You can get 1% in a savings account, or 2% in a five-year CD (e.g., at GS Bank, the online bank recently started by Goldman Sachs). And that’s FDIC insured and without buying some insurance contract you probably don’t really understand.
By the way, I think it would a fair question to ask the advisor what fees and commission would be on the sale of the policy.
The financial advisor has already spent a lot of time with us and given my wife and I valuable advice for doing things such as setting up a revocable trust for our estate. We intend to buy a vacation home in the next year and need the money to be in a fully liquid account and in a situation where there is no risk to the principal. The Life Insurance policy he is suggesting also has a stock index plan that has the potential to return more than 2.3%. But it also has potential to reduce the principal in the short term.
Many years ago we invested in high interest first trust deeds (hard money lender). On paper it seemed to be a no-brainer. In practice the guy running the company that was managing the trust deeds was a crook and we barely ended up getting our principal back plus a lot of stress in the meantime. I’m trying to find out if MECs are on the up and up and if there are gotcha’s we haven’t been told about.
Wait, your investment advisor is suggesting you invest money you will need within a year in an insurance contract (the Modified Endowment Contract)? That sounds like a bad idea. I think you should just put it in an FDIC-insured bank account. Possibly a CD. You can earn about one percent interest, but the money will be there when you need it.
I agree. Buying a life insurance policy for no other reason than to get slightly more interest than a passbook account sounds fishy. I’m trying to find objective evidence for why it’s a bad idea. BTW, The amount of money involved is more than is covered by FDIC.
First off, if you’re planning on needing a large sum of money in the next year, your primary concern should be safety of the principal, not the chance of making 2.3% interest, especially if “it also has potential to reduce the principal in the short term.”
Second, the commissions and fees have to come from sonewhere. I’ll bet there actually is a surrender charge if you tap into the policy too soon. After all, the insurance company and your advisor want to make their money up front. Even if the commission and fees only add up to 1%, that cuts the real yield down to 1.3% – and you’re back in passbook savings account territory.
There won’t be that much interest to come out in the first year or two, which means you’ll be drawing your principal right away. Which means that 2.3% interest will be paid on a smaller balance.
If the sum of money you’ll need is too large for an FDIC-insured account, then split it up among different banks, each account will be independently guaranteed.
IMHO, you should consider your money to be in three piles: short-term funds you’ll need in a year or two (passbook savings and money markets), medium-term (CD’s and maybe a good bond fund), and long-term where you can afford to take a little risk to get a higher return 10 years or so down the road.
For purposes of this discussion, assume there is no surrender charge. This is what our financial advisor is claiming. My wife and I always read the fine print when a large (or even small) amount of money is involved. We will not proceed with this unless, after reading and understanding the contract, we are convinced that there is no surrender charge.
Again, I’m hoping someone with personal experience with this type of product will chime in.
One Idea that has occurred to me is to ask about the rating of the insurance company that is supplying this product. Of course, I have no idea who rates insurance companies.
As far as piles of money. We also have well-funded 401K and IRA accounts and I’ll be collecting a moderate pension when I retire. The qualified money in the 401K and IRAs are mostly invested in S&P500 index mutual funds.
OK, I have no experience with this, but am wondering; did the “financial advisor” know that you will need the money within a year or so when he/she suggested the product? Because it seems unsuitable for your needs and I wonder if the other advice you’ve received is just as unsuitable.
We did this a few years ago. We had about 100k that needed to be somewhere but still liquid. My uncle, who I trust completely, advised a similar policy through his company. We had no problems with it, withdrew it after about a year with no penalties or other nonsense, and received the promised interest, which we did have to pay taxes on, of course. I think it was 3.5% interest. Would do again.
Calling yourself a “financial advisor” doesn’t mean anything. Ask him if he’s a fiduciary who is legally obligated to put the client’s interests ahead of his own. I’ll bet you he says no. Then ask the self-described “financial advisor” what happens when you die. Does your beneficiary receive the full death benefit PLUS the savings account? Or do they reduce the death benefit by the amount you have in your savings at the time you die? I’ll bet he says you get either the savings or the death benefit but not both.
One of the first questions I asked when we started meeting with the financial advisor was whether he was a fiduciary. His response was yes and he reiterated that he was legally responsible to put my needs first. Obviously, when I withdraw money from the MEC, the amount my beneficiary receives at my death is reduced. If I die before I’ve withdrawn anything the beneficiary gets somewhat more than the money I put in. Not sure, but it may have been 30% more.
What fees does your financial adviser get? You need to subtract these from your interest rate. For example, if he takes 1% up front, you need to reduce your effective rate for the first year by that much.