American Medical Association - Physicians Financial Summit in Orlando, Florida - May 1-4, 2016

Trust Owned Life Insurance

Trey Fairman: So, I have three hours. I’m going go off-script. So, this has been a great
experience for me, and hopefully, for everyone here. I’ve been at every presentation, and I’ve
written down some notes. I wanted to start with just a general framework of what we’re going
go through here. Though this title sounds important and complicated, I like to think of this as
just common conversations that I have.

Let me tell you a little bit about what I do and that will frame it for us. I’ve been in the
insurance business since 1993. I started at a very large, mutual, old school insurance company.
In 1997, I transferred to a firm very much like Millennium and have spent most of my time since
then working with private bankers, stockbrokers, attorneys, CPAs, trust officers. Along the way,
I got my law degree. I got lucky enough to pass the bar the first time. I was crazy enough to go
back and get my graduate degree in tax law. I have seen a lot of changes. I caught the tail end of
what I like to call “the old school insurance planning” and I’ve been lucky enough to watch as
everything has consolidated.

If you think about financial planning and what’s happened in our industry since the late
‘90s, you have a lot of firms, whether they’re Wall Street firms, banks, insurance companies,
becoming more efficient, merging, integrating, and trying to learn what each other does very
well. They take the best parts of what each entity does and try to move them forward. As Herb
said in the beginning, my goal today is to really make you think. We’re going to talk about a lot
of topics. I turned in my presentation last week, and it’s going summarize most of what we
looked at yesterday and this morning. I think it’s a good tie-in.
What I’m going talk about more is what I talk to clients and advisors about. Feel free at
any point to raise your hand and interrupt. I have about 30 slides, so I can talk about the first
three. We can talk about all of them. We can talk about whatever you’d like.
Changes are happening whether you like them or not. As I’ve already said, our industry’s
changing. One of the biggest changes I want to focus on at the beginning is the way we talked
about planning pre-2008 and post-2008. So, pre-2008, estate tax planning and insurance
planning and financial planning was very much forward-thinking. We would run financial plans
that would have 60, 70, 300 pages to them.
They would make all these assumptions and that was great because everyone thought
the world would just progress over time. 2008 happened. We all took a big step backwards. We
retrenched, and a lot of what the planning today is how I can accomplish my goals in a way that
I can be flexible, I can change along the way, and if my goals today aren’t the same in five years,
that’s okay, and I’m not going be penalized for changing my mind. Meaning that, we’re not
going talk about irrevocable planning. We’re not going to try to over plan. One of my favorite
poets, Yogi Berra, once said, “If you don’t know where you’re going, you might wind up
someplace else.”Again, we’re going think about what we’re doing now, why we’re doing what we’re
doing. We’re going talk about some ideas that I have that people have shown me. Again, the
goal is just to think about it. Feel free to interrupt me and ask me at any point. Before we get
started with this, part of what I do in addition to my regular job is I am part of a teaching group
where attorneys and CPAs and trust officers collaborate with each other and teach each other
about what we do. I’m going give you some stats from a class that I taught last Wednesday.
Let’s talk about what’s going on right now. People are reaching 65 at a faster rate than
they ever have. Today, there are about 40 million of them. In the year 2030, it’s projected to be
72 million. We’ve known about that. That’s not a big surprise. We are in a prolonged ultra-low
interest rate environment. That’s challenging for us as individuals, but it’s also incredibly
challenging for insurance carriers, for banks, and for Wall Street firms. As I said earlier, the
financial services industry is consolidating. They have done a good job of trying to reduce the
drag of employees, of healthcare costs, but that challenge is still there. The tax law has changed
Again, historically, the financial services industry has been more focused on the
wealthier clientele, estate tax planning isn’t that important because, under the current
exemptions, a husband and wife can shelter about $11 million. So, you hear this. We’re more
mass affluent based. It depends on who you’d like to talk to about what that means. For the
next 54 minutes, mass affluent is a net worth under $11 million. So, no estate taxes. Good
news, you can keep everything you own and spend it all. That’d be great. We’re going talk a
little bit about IRA planning, if you have a net worth over that $11 million. Those are the
If you turn the lens to me and our industry, what are we as an industry doing to help
with that? A big insurance carrier did a survey a few years back. They found that 35 percent of
consumers that purchased insurance worked with an advisor to figure out what the proper
amount of insurance is. I made a comment earlier that back-of-the-envelope, it’s super easy.
It’s ten to 15 times annual income. I work with most of the major Wall Street firms. I’ve seen
financial planning software from all of them. They are all very good planning tools, but at the
end of the day, they’re all going tell you about income times ten to 15. Is that the right number
for you? I have no idea.
Some clients, typically men, say “I’m not buying insurance. She can get remarried. Who
cares?” That usually doesn’t go so well with the wife. The idea is to really just think about it. In
that same survey, 20 percent of people admitted they simply guessed how much insurance they
needed. Think about yourselves for a moment. Most group plans through work give you income
times two to three for free. Most financial plans would tell you that you need income times ten
to 15. Maybe two to three times is great. Maybe ten to 15 times is great. Who knows? Just
think about that and why that makes sense. How long do you need it for?
Our insurance industry would have you believe that you need insurance forever. You
probably don’t need insurance forever. At some point, you’re going to retire. That, by
definition, means you don’t need cash to flow into your estate. We’re going to talk a little bit
about that too. Finally, when it comes to financial planning, one of the very large banks will
admit quietly that of all the financial plans they run, less than two percent have insurance
planning pages in them. So, if you think about yourselves, most financial planning is retirement
planning. What is retirement planning? How much money do I have to put into a bucket,
assuming it earns X percent, so I have enough money when I retire?
There are a lot of other factors that pop into that. What is my spending per year?
What’s inflation? At the end of the day, that’s simply what retirement planning is. Insurance
planning is no more complicated than saying the person who’s earning the money that goes
into the bucket isn’t around to put money into the bucket. So, how much of a lump sum do I
need to deposit into the bucket? Insurance planning can be very simple. I’m going try to make it
as easy as I can. Remember, as we are walking through these, these are conversations I would
be having with advisors, who are either accountants, attorneys, CPAs, financial advisors, who
are doing a lot of planning for their clients and are using insurance where it fits as opposed to
using insurance to fix all the problems in the world, which it doesn’t do very well.
Last stats here. As the financial services industry is consolidating, which is what I
basically just pointed out, most of those planning conversations, when it comes to insurance,
and think about yourselves again, are being had with people who don’t do insurance planning
all the time. They do it part-time. They are an accountant, attorney, bank advisor. What we’re
going talk about here is what I think works well for individuals your age, what you’re trying to
do here moving forward. Finally, I’m going say this because it’s probably going to come up,
insurance is not a religion. It’s just math. I have some clients who say, “I don’t believe in
I don’t know if you can’t believe it. The translation may be, “I don’t want to spend the
money” or “My kids will have enough after I die.” That’s all perfectly well and good. At the end
of the day, this is just a math exercise here. As I go through this, feel free to interrupt or tell me
I’m not doing something right or if you have questions.If we think about financial planning in general, I wouldn’t say there’s a blanket
statement on how we do everything. There are two primary risks that we’re going to look at
today, what the risks are when you’re working and what the risks are when you retire. If we
break that down into four areas, we’re going focus on loss of income for your family. Think of
your biggest asset as the ability to earn an income. Same idea, but from a business perspective,
if you own your own business. How do we protect the income in your business? Those lines will
blur. We’ll try to keep that clear Liability protection and health insurance. Loss of income. As we just said, that’s
your most valuable asset. That’s probably not news to you. You’ve probably heard that since
the day you entered medical school. General rule of thumb, you should replace about two-
thirds of your pre-tax income. So, if you make $10,000.00 a month, a general rule of thumb is
you should have $6,600.00 per month to replace that lost income, if you’re unable to work. Life
insurance, the general rule of thumb is ten to 15 times annual income. These are rules of
thumb.Some clients say, “I don’t think I need that much. I need two to three times
income.” That’s fine. A friend of mine who is an ER physician at Scripps, which is in San Diego,
which is where I work, says, “I just want to cover the monthly burn rate.” That’s not necessarily
two-thirds of pre-tax income. It’s whatever makes sense.
There are a lot of different types of disability insurance. I don’t think it’s an either/or
conversation. Usually, what we find with physicians is, it’s a layering conversation. Think about
insurance companies and whether it’s disability income insurance, long-term care insurance,
life insurance, they’re in the business of assessing risk. If we move from left to right, one of the
first things to understand is it’s easier to get group insurance on the left because you typically
don’t have to prove that you’re in good health where, on the far right, you do have to prove
that you’re in good health. Sometimes we would want to prove we’re in good health because
we have much stronger policies.
Think of insurance as a contract. It’s a promise to pay. As you see, we could go through
all these, but we’re not going go through it too much. The contracts vary by what is considered
disability. Think about yourselves. Some DI policies say that if you’re unable to work in your
own occupation, we’re going to pay a claim. If we want to get into the nuances of that, what is
your own occupation? Is it your specialty or is it just being a physician? We’d obviously prefer it
to be a specialty coverage. Some of them are like that. We would suggest you get as much of
that as you can or as you’d like. Some of them aren’t like that. Some of them are portable,
meaning if you leave that employer, you can take it.
Most group policies are not portable. Again, in a perfect world, we’d like to get a
contract that protects your specialty. You own it. You pay for it. You keep it as long as you want.
No one else can cancel it. That would be the perfect world. Most physicians don’t have the
perfect world. They sort of acquire some of it as we go along. Let’s look at an example here.
Before we do that, let’s talk about taxes. The benefit of disability income insurance may not be
tax-free. Let’s talk about how this works. If you pay tax on the premium, the benefit will be tax-
free. If you don’t pay tax on the premium, the benefit will be taxable. Accountants like to get as
much of a tax deduction for you as they can, which is a good thing usually.
They may suggest you deduct the cost of your premium. That’s good from a tax planning
perspective, but it may not be good in a claims scenario because if you go out on claim, you
have to pay income tax on the benefit. It’s not always one way or the other, always good or
bad. It’s hard to say. Again, it’s something to think about. I met with a gentleman last week who
was not a physician, but I thought this was a pretty good scenario. A 37-year-old sold his
business to a bank. He’s working for the bank. He makes about $1 million a year, which is about
$83,000.00 a month. Under our rule of thumb, 66 percent of pre-tax income is $55,000.00. He
has his own individual policy and pays for it with after-tax money.
So, that’s $3,750.00 pre-tax, which you see there on the column. It’s not taxable. So,
cash in his pocket, if he’s disabled, $3,750.00. Then, he also has a group plan from his employer,
which he didn’t have to take an exam for. He doesn’t even have to pay for it. It’s free. It’s
$12,000.00 a month. When we first started talking about it, he thought he had $12,000.00 plus
$3,750.00, which is $15,750.00. However, in California, we pay a lot higher taxes than 40
percent, so it’s only worth $7,200.00 to him, if he goes out on claim. It’s about $11,000.00 a
month. Not bad. We talked about what the gap is. When he sells his business, a lot of his
money is locked up in private equity funds and two or three other business transactions, so he
has a runway.
This is an idea we’re going to talk a little about here today. He’s thinking he needs to
work about five to seven more years. So, we’re really only doing planning until he retires. When
he retires, that’s a whole other type of planning conversation, so the risk for him is if he’s
disabled in the next five to seven years. Some interesting insurance policies that are out there
that some people haven’t heard about. Look at this a little bit differently, and the challenge is
most insurance policies that you’re going hear about are only going to insure your income up to
$15,000.00 to $20,000.00 per month. That’s usually pretty good for most people. There are
obviously gaps sometimes.
So, the options we talked about with him to get up to that $83,000.00 a month, let’s
look at some insurance that’s only going be there for five years, pays $50,000.00 a month and
by five years, I mean it renews every five years. His annual premium is $9,735.00. Interestingly
enough, if he wants to pay for it in a lump sum, he can actually save 20 percent on that, just by
paying $38,900.00. Obviously, this is not a standard conversation, but I think the point of this is
that there are options that float around the market from time to time that are maybe worth
looking at. Maybe they’re not. Option B is somewhat similar, but a little bit different.
$50,000.00 a month for a shorter duration, for five years, not ten, and a $500,000.00 lump sum.These types of policies renew every five years, and again, that’s what his runway was.
He was concerned about the next five to seven years. Something to think about. Within the
AMA and through our firm, they have DI policies. They don’t provide $50,000.00 a month, but
they’re out there as well. You probably have your own as well. I’m a finance person, and I
remember sitting at my boss’ desk, and he was describing to me how physicians at that time
could buy disability income insurance, and if they went out on claim, they would get over 100
percent of their pre-tax income, tax-free, and they would get paid that amount for life.
That seemed like a really good deal, and I was only 21 years old. “Are you sure this is
right?” “Yes, we’re doing a lot of planning with this.” I moved to California in 1995. A lot of docs
got that stuff, I guess, because we couldn’t offer that in California anymore. There was a lot of
claims experience with that. The point is the disability income market has changed. If you have
coverage, it’s probably really good, so we probably can’t get a better type of coverage. We’re
talking more about the amount and how that fits in with your current plan. That’s loss of
income for yourself.
We’re going to try and make this not too confusing. Think about your business entity.
Let’s assume you’re disabled. You have had an accident. You’re not able to work. If you’re out
for a year, what happens to your business? How does that survive? So, we’re going look at
three ideas here. This idea has been around a long time. It’s called business overhead expense
insurance. It simply pays the bills. So, where personal disability income insurance is providing
you with income to pay your household expenses, this provides income to pay the rent, keep
the lights on, pay salaries at your business.
This is an idea a business owner actually came to me with in 2009. So, we had just had
the 2008 setback. This owner called me through a financial advisor. It’s based on the premise
right there at the top. Think about your business. It’s probably worth more with you practicing
in it than without you. This owner said, “Before 2008, I was earning about $800,000.00 a year,”
and on a valuation conversation, his business was probably worth five times that number. So,
$800,000.00 times five is $4 million. He continued to say, “After 2008, I’m probably only making
$300,000.00 a year,” and the valuation multiple is three. So, $300,000.00 times three. Now, it’s
worth $900,000.00.
So, $4 million before the correction, $900,000.00 after. He then proceeds to say, “I’m
going work really hard on my business for probably the next ten years. That’s my runway. I’m
going put all of my profits back into my business. If something happens to me, my wife and my
family have a business, but the business isn’t worth much without me. What do I do?” I often
hear physicians and advisors talk about buy-sale planning and key person planning. That’s all
great, and we can talk about that, but what I’ve seen a lot is buy-sale planning is just drafting of
legal documents, which is important. Maybe a little bit of key person planning too. At the end
of the day, most businesses don’t have liquidity value there.
So, what developed out of that conversation is to say, “What number makes sense for
you to protect your family either to give them cash or provide them monthly expenses?” This is
really where it hits home. A ten-year term for $1 million for a 45-year-old costs $1,000.00 a
year. It really costs about $900.00 a year. Think about that for a second. Remember what we
said earlier. Most financial plans will say you need income times ten to 15. Most people have
income times two or three. This gentleman had an asset that was worth $4 million. After the
correction, it was worth $900,000.00. If something happened to him, his family would have no
He could protect that loss of income of $3 million for $3,000.00 a year. It’s not
complicated. It’s not permanent. It’s not perfect, but for him, it made sense and allowed him to
get back to what he does, which is running his business, driving the profit. A pretty simple idea.
Practice financing loans. We also partner with some large banks. At least in San Diego,
when those banks make loans to physicians to buy machines or to purchase practices, they are
concerned about how those loans will be repaid. That makes sense. We’re in a low interest rate
environment. A lot of credit challenges. Some banks are requiring or strongly suggesting that
they want some sort of protection, if the physician or the primary driver of the revenue in the
business is unable to work. You may have personal disability income insurance, and the bank
may love to secure that to pay back their loan, and that’s easy and quick, but if you’re disabled,
that money goes to the bank. It doesn’t go to your family.
So, there are niche products out there. This is one of them that can be structured to
make the remaining loan payments on the loan to the bank. Very similar to personal disability
income insurance, which provides a benefit to you and your family. This provides a benefit to
the bank, indirectly to you, because it pays off the loan. Umbrella liability insurance. One of the
areas I’m not an expert in, but I talk about it all the time. Clearly, homeowner’s insurance and
auto insurance can only go so far. Umbrella liability goes beyond that. Not work-related or
business-related, but if the gardener falls and breaks his leg or someone falls off the ladder.
Think of it again as layering, like we talked about before.
We’ve got group disability insurance. We’ve got affinity programs. We’ve got individual
coverage. This is something that sits on top of what you already have, provides you with
coverage over and above what your current policies do and is unbelievably inexpensive. It’s
$500.00 a year for $1 million worth of umbrella liability. Very inexpensive. Health insurance.
This is popping up more and more too. Not my area of expertise, but I think you all are probably
familiar with it, for sure. How do we insure the risk? Obamacare, with the qualified ACA plans,
other plans, critical illness, long-term care. We’re going chat a little bit about that later.
Hospital expense plans. What are the risks out there that are going to help us not have
to tap into savings and retirement plans? This is clearly one of the ones that are there. Now,
we’re going to shift. Now that I’ve reached retirement, what are my concerns? Just to back up a
second. Remember, when you retire, what are you saying in plain English? You’re saying, “I
have enough money. If something happens to me or my wife, I don’t need a lump sum to flow
into my estate. It may be nice, but I don’t really need it. I have enough money to live on. My
kids are gone, college is paid, mortgages are paid.” The AMA financial preparedness reports are
great. Someone had asked yesterday, “What’s the number I need to save when I retire in my
The last slide you’re going see here is the AMA insurance Web site. You can read all
these reports. I don’t have the exact IRA number, but from the 2013 report, the average
retirement savings of physicians 66 and above, 43 percent of them had between $1 million and
$3 million. That’s not just IRA money. It’s probably other assets. Thirty percent had over $3
million. So, the summary number of that is 73 percent of physicians aged 66 and above that
responded to the 2013 AMA financial preparedness report had at least $1 million saved when
they retired. As we heard about before, one of the areas that we talk about is “What do we do
with IRAs? How does that work?”
Odds are if you are 65 or over, depending on what survey you’d like to believe, there’s
about a 68 percent chance that you’ll need long-term care. And another survey will tell you that
less than ten percent of people have actually done anything about it. So, seven out of ten will
need it. One out of ten have done anything about it. Maybe some people have thought about it
and have chosen not to do something, but I think that’s a pretty telling stat. Can we go back a
slide? I have another good factoid here. In the fall of last year, I did some outreach programs. In
San Diego, two physicians were talking about IRA retirement planning only.
I started off by putting a slide on the screen that said, “90 percent.” I let it sit there for a
little while, and I started. I said, “What does that mean?” Remember, I live in San Diego. If you
Google 90 percent in San Diego, you’re probably going come up with the following factoids. In
the fall, there was a 90 percent chance of El Nino in San Diego, which means it’s going rain
more than one day. That’s one factoid. No. 2, 90 percent of Android mobile phones have critical
security bugs. The next one is pretty interesting. Ninety percent of U.S. bills have residue from
illegal drugs. That’s not what I was there to talk about. I was there to talk about the fact that 90
percent of inherited IRAs, which in plain English means, IRAs that go to kids are liquidated
within six months.
Again, I don’t care. I’m gone. That’s one way to look at that. The other way to look at
that, which we’re not going talk about today, is there are other types of trusts you can draft
that receive the IRA, make them creditor proof, and we can do some planning with that. Doug
was chatting a little bit about this. Ninety percent of IRAs that go to children are liquidated
within six months. Then, Bill Zelnick was saying yesterday that, in California, 90 percent is also
when you add up federal income tax rate of 39.6, the top state rate of 14.6, and the federal
estate tax of 40 percent. Those numbers total 93.2 percent. The good news is, there are some
credits. If your net worth is over $11 million, and you try to leave your IRA to your kids, the tax
rate is not 93. It’s about 60 or 61. It’s still pretty big.
So, to set the baseline for how IRA planning works, in theory, the IRS says, “We’re going
let you put money away pre-tax, whether it’s in a 401(k) plan or defined benefit plan or
whatever.” Most retirees when they reach retirement age are going roll that or transfer it tax-
free to an IRA. There are many good reasons to do that. It’s a lot more flexible, a lot more
investment options. Some plans just kick you out. They say, “You’ve retired. You have to leave.
Take the money.” So, the money rolls over tax-free. Then, at some point, which is common, the
IRS is going say, “We want some tax revenue.”The rule of thumb is that you have to start pulling out an amount April first the year
after you turn 70 ½. We’ll talk about that here in a second. The way it works is pretty simple. It’s
based on life expectancy. We have Mr. Age 70. His IRA is worth $800,000.00. The divisor or
what we divide that number by is 27.4. His required minimum distribution, or RMD, is
$29,197.00. So, when he pays tax at 33 percent, he’s got $19,562.00. Pretty simple, right? I
think in the late ‘90s, when these things were growing, sometimes we say ten, 15, 20 percent.
Assuming it grows at four percent, when he goes back the next year, it’s actually grown. It’s
His divisor hasn’t gone down by one because if he lived a year, odds are he’s going live
longer. Now, it’s 26.5. He pulls out $30,000.00 and pays his tax. If we fast-forward four years
later, again, it still hasn’t gone down, but the value hasn’t dropped that much either. The
question becomes, what do we do with these things? Hopefully, the answer is, spend it all. Go
on a trip. Buy a car. Spend it. That’s the best estate plan, right? A lot of clients, by default, say,
“I don’t need the money. I’m just going reinvest it.” They may reinvest it in the same portfolio
with the same stock market risk that the IRA has. Maybe they’re going buy tax-free muni bonds
or put it in a CD. Who knows? Maybe they give it to the kids.
A lot of estate planning talks about how we can gift money. We’re going talk about that
here in a second. Sometimes kids need money today. In the current estate tax laws, you can gift
$14,000.00 per husband and wife per calendar year. It used to be $10,000.00. So, now, you can
gift $28,000.00 a year to your kids every calendar year. You can use it to purchase long-term
care insurance. We’re going to look at that. We can buy insurance. Doug was chatting about
that. We’ll talk about why we would even think about that. Again, you’ve got this income
stream, and one of the common things I hear from retirees is, “I don’t know what to do with
the money.” Spend it. That’s great.
Let’s look numerically at what else we can do here. Before we do that, this is from the
2013 survey as well. One-third of physicians have chosen to fund long-term care insurance to
pay for long-term care. Remember, nationally, seven out of ten are going to need it. Nationally,
one out of ten have done something about it. Three out of ten physicians have actually done
something about it. That’s great. Twenty-seven percent have said, “We looked at it. We’re not
using insurance. We’re going pay for it with our own money.” That’s fine too. At least they’ve
thought about that. A third say, “I don’t know what I’m going do.” I think that’s the most
concerning. Who knows?
Let’s look at this. Karen outlined this yesterday, which was great. I’m going go through it
again just to hammer it home because I get a lot of conversations from clients and advisors,
frankly, “I know about long-term care, but I don’t know what that means numerically. I know
what college planning is. I know I can figure out what that means.” If you want to write this
down, Genworth has a Web site, and you can Google Genworth, G-E-N-W-O-R-T-H, cost of care.
You can pick the state and the city you live in, and it will tell you what the cost is. The table that
Karen had up yesterday is a screenshot from that Web site. Genworth does this every year. It’s
a great tool.
If you remember, yesterday, it had assisted living, home healthcare, semi-private
nursing home, private homes. In Southern California, if I take the average between a semi-
private room and a private nursing home room, it’s about $300.00 a day. Statistically, less than
13.1 percent of all claims last longer than three years. So, the inverse is, eighty-seven percent of
long-term care claims last three years or less. As a starting conversation, let’s look at providing
a $324,000.00 pool of money. If you self-insure, that basically says, “I’m going pay for that care
cost dollar-for-dollar.” Inflation in Southern California is probably about ten percent a year.
Nationally, it’s about three percent.
If you’re going to self-insure, that cost is growing at six percent. That means what you’re
self-insuring with has to grow at six percent too, just to keep pace. Most health insurance,
Medicare, plans will pay for the first 90 days, so that’s typically how we structure this. Karen
brought this up yesterday too. If you’re buying long-term care insurance when you’re 50, you
could need it tomorrow, but the odds are, you probably won’t need it for 20 years or so, so
we’d like that benefit to inflate. If you’re 75 and buying long-term care, the odds are you will
need it pretty soon, and it’s expensive, so we don’t want to put inflation on that. That’s the
finance part of it. That’s what the math is.
So, how do we do it? Four ways. Self-insure, earmark money. “I’ve got cash. I’m going
pay for it.” I buy traditional long-term care, which is like term insurance with a smaller annual
premium, and it continues forever. It’s like car insurance. If I don’t use it, it has no value to it.
Most likely, that cost will go up. Almost certainly, that cost will go up. As we’re doing financial
planning for people entering retirement, the last thing we want to do is put another contingent
liability on the balance sheet that we have to cash flow to pay. And we don’t know what the
cost is going to be. Then, we’ve got these hybrid products. Let me just tell you why I think that’s
Long-term care models have only been around since the mid-‘70s. You know better than
anyone that as medicine’s gotten better, people live longer, but the quality of life towards the
end is maybe not as great. Life insurance actuarial models have been around for hundreds of
years. The insurance company got really creative in the mid-‘80s and said, “We’re on the hook
to pay the death benefit when this person dies.” Let’s assume that’s 85. “Why don’t we give
them access to the death benefit before they die tax-free to pay for long-term care? We’re not
going give them access to all the death benefit. We’re going discount that a little bit. So, we’ll
give them access to 90 percent of the death benefit.”
From your perspective, that’s an interesting model because those models won’t change.
Those numbers are all guaranteed. Even if clients say, “I only want to pay $7,000.00 a year for
long-term care insurance,” we can use life insurance products that will guarantee the premium
will be $7,000.00. We can guarantee what the duration is. We can guarantee all of that. With
the traditional long-term care policies, we can’t really guarantee much. Then, we’re going talk
about these hybrid annuity plans as well, which Karen talked about yesterday too. Think about
yourselves. One of the conservations that I like to have with clients is to say, “Do you have any
Most clients have collected insurance policies over the years. Sometimes there’s really
no rhyme or reason why they have what they have. They haven’t looked at it forever. They
forget that it’s bond-driven or stock market-driven and it may not be around forever. They may
have what I call “the old type.” Old type meaning, it’s just life insurance that pays a death
benefit. If you want to get access to money while you’re alive, you get the surrender value. If
we look at the column that says, “old type,” this gentleman didn’t need insurance anymore. His
kids were grown. His mortgage was paid. He didn’t have any need for the death benefit.
We were chatting with him, and he said, “I have this $350,000.00 insurance policy. I’m
paying $300.00 a month. It’s worth about $112,000.00.” He said, “I’m really concerned about
long-term care. I’m not really sure what to do with it.” His long-term care amount, if you want
to think about it that way, is what the policy was worth, $112,000.00. Cancel it, and that’s what
he has to spend. As competition and actuarial tables have gotten better, insurance is cheaper
than it was when he bought this 20 or 30 years ago. First commentary to him was, “Why do you
even have this? Why don’t you just cancel it? Take your $112,000.00 and invest it.” What I
thought was interesting was, he said, “No, this is my insurance money.”
“I’m not sure what that means.” He said, “This is for insurance.” “But we don’t need a
death benefit, right?” “No, I don’t really need a death benefit. I’ve got plenty of assets, but I am
concerned about long-term care.” Just by parking it, we transferred it from the old insurance
company to the new insurance company. The bottom row is really what we’re doing. Look what
happens. Now, he has three times more money to pay for long-term care. Additionally, he saves
$300.00 a month. As we’re retiring, we’re eliminating expenses, which is good. His life
insurance amount went up a little bit. Not really why we’re doing it.
The only bad news to him is, if he cancelled it, right after he did it, he wouldn’t get
$112,000.00. He would get $96,000.00 back. So, he went from the position of “What am I doing
with my assets? Do I need the money to live on? Do I want to travel the world with my
$112,000.00?” Just by repositioning it, he’s able to get three times more money tax-free to pay
for long-term care and saves $3,000.00 a year. That’s example No. 1. Again, Karen stole my
slides. The Pension Protection Act of 2006 did a lot of good things. It talked about how
annuities can be used to fund long-term care. We’re going to go to the next page because that’s
not really that important. Think about yourselves.
This is a physician I was chatting with in the fall. He has accumulated a lot of money,
which was great, and he somehow ended up with four of these annuities. We’re just going talk
about one. They were each worth about $250,000.00. He had done very well. He had put
$100,000.00 into them, and they had grown over time. Annuities are ordinary income on the
gains, no matter how long you actually hold them. So, he had $100,000.00 in and a gain of
$150,000.00. If he cancelled it, he would have to pay ordinary income on the gain number. He
didn’t really have any need for these. He wasn’t quite sure why he had them.
What the Pension Protection Act allows us to do is, as opposed to parking the money in
an old, non-Pension Protection Act annuity, park it in a new annuity and he then creates a long-
term care benefit you see on the bottom right of $632,000.00. There is a cost in that. If he left
the annuity where it is, that $250,000.00 is going probably grow at a faster rate than if he puts
it into the long-term care annuity. There is that extra drag of paying for long-term care costs.
From his perspective, he took $100,000.00, and if he needs long-term care, he just turned it
into $600,000.00. That’s all income tax-free money for him.
Qualifying for these types of policies is actually pretty easy. You still do have to pass, but
there are arbitrage opportunities where if you’re buying traditional long-term care policies,
they’re really looking at if you have a bad back or if you use a cane. These types of products still
look at that, but not quite as much. So, we’ve been able to talk to a lot of clients who maybe
couldn’t qualify for traditional long-term care and these things work perfectly for them. The
slide is in the wrong place, but I’ll quickly talk about it. If you think about what we talked about
before, disability income insurance provides income to yourself to meet living expenses. If
you’re not able to work, you’re also not funding for your retirement plan.
There are solutions out there where you can purchase insurance that say, “If you’re
disabled, we’ll fund your 401(k) plan for you.” Whether that makes sense or not, I don’t know.
At least that’s an interesting conversation. No one hears the back story. “If I’m disabled, what
happens to my 401(k) plan?” Let’s say a physician 40 to 65, putting $1,250.00 a month away,
earning five percent. When they retired it would be worth $651,000.00. Statistically, if you were
disabled at that age, it would be for about four and a half years, but if you’re disabled for three
years, her balance at age 65 would drop from $751,000.00 to $632,000.00. If we don’t have this
type of insurance, maybe we allocate the money to grow faster and save more money. Not that
this is the perfect solution, but again, something to really think about.
Taxable IRAs. As I said earlier, the estate tax exemption this year is $5.45 million, so if you’re
single, if you’re worth more than that, you have a problem. If you’re married and you put those
two numbers together, let’s call it $11 million. If you’re worth more than that number, the
amount over $11 million is taxed at a rate of 40 percent. We have already talked about the
combined tax problems. That was the 90 percent. You do get a deduction, so it’s not 90. It’s
less. The challenge we see with larger estates that have estate taxes due, and we already heard
that children liquidate inherited IRAs 90 percent of the time, is that estate tax bill that comes
due is due within nine months, and it’s due in cash.
IRAs are pretty liquid assets, so you grab the money to pay the IRS. We’re going to talk about
why that’s important in a second. Changing gears, Medicare supplement insurance. Medicare is
going to pay, by its general structure, about 80 percent of your costs. One of the other
conversations I’m having a lot this year is “Can I insure for that other 20 percent?” The answer
is yes. It’s commonly known as Medicare supplement insurance. The AMA has a plan that
seems to work pretty well. Life insurance. The term I’m using is “non-correlated.” John was
chatting earlier about MetLife’s product. We’re going to see some numbers up here. The point
with this is, think of your retirement assets invested in the stock market.
When I’m saying “non-correlated,” I’m talking about assets that do not depend on what the
stock market does. No matter what the stock market does, this doesn’t perform that way.
These are fully guaranteed exercises. One exercise would say, that RMD that I get, and I don’t
need, and I’m concerned my kids might not have enough money to live on, let’s say that’s
$56,000 after tax. If I take that for ten years and I say, “How much insurance can I buy?” The
number is $1.7 million. Forget whether it’s whole life or any of that crazy stuff. If those two
people pass away in 25 years, $1.7 million flows into a trust. What did we do? We paid
$56,000.00 a year for ten years and put $560,000.00 in, and your kids got $1.7 million.
What did we earn from that transaction? 5.57 percent. That’s a guaranteed tax-free number. A
good comparison are tax-free municipal bonds that are probably three percent. This doesn’t
benefit you. It could benefit your spouse maybe. It’s for your kids. Interestingly, if you go down
to the bottom with that, we can drive up the cash-on-cash return to 8.5 percent. It’s not for
you. It’s a way to transfer wealth in a very guaranteed, effective tax way. This is what John was
chatting about, and what I started with. Things are changing. Insurance companies are finding
that estate tax planning isn’t as great as it used to be because clients who have over $11 million
are the only ones who pay estate taxes.
Go back to the mid-‘90s and that exemption was about $600,000.00 per person. So, in
California, anyone who owned a house was subject to some sort of estate tax. I think the tax
law growth has been great. What’s interesting about insurance assets is, sometimes there are
interesting opportunities because the way they invest money is very long-term and there are
arbitrage opportunities. This is the MetLife policy here. There are only two or three of these out
there. I thought John did a great job chatting about it. I’m going to frame it a little differently.
Think about five-year money. Clients say, “I’m not interested in the stock market. I’m just going
sit on my money. What can you offer me in CD rates?”
Jumbo CD rates for five years are 2.18 percent. This was two weeks ago. Five-year Treasury
rates are 1.16 percent. MetLife’s insurance policy for a 55-year-old, so cash-on-cash, we put
money in, we cancel it in five years, we get a number back in five years, which is taxable.
What’s the number? What did I earn? 3.15 percent. It is insurance. It has a death benefit that’s
great. We can talk about why that’s helpful, but just from a “What do I do with assets that I’m
not going need for the next three to five years?” This is an interesting arbitrage opportunity. It’s
not an alternative checking account. It probably doesn’t work well in the first 12 months, but
it’s an interesting conversation.
It’s more for yourself and the cash value exposure than for your family. These products have
been around in the past, but they were typically reserved for very large corporations that would
have to pay $10 to $20 million into them. Again, just an example of how the world’s changing.
Insurance companies are trying to gather assets just like financial advisors are. MetLife’s making
some money off this too, probably one to one and a half percent over and above what they’re
actually crediting you. So, it’s good for them too. Just a different way to really think about asset
planning. That’s it. I talked about a couple surveys. This is the Web site,
If you go there, you can bounce around. The surveys have been going on since 2013. Maybe a
little bit before that. I have nine minutes and 26 seconds left, so if anyone has a question, I
would love to answer them. Yes?
Male Speaker 1: So, the 3.15 percent is guaranteed?
Trey Fairman: It’s not guaranteed. Let’s talk about the investment world. What are you going
get on a guarantee? If you walk into anybody and say, “What do you guarantee me on my
money?” That’s the CD rate. What I talk to most clients about in today’s world is “I’m earning
nothing in my bank account. How do I earn more than that?” The conversation is “What sort of
risk do I want to take?” The guaranteed number on this is not super attractive. My example is a
male, 55, puts in $410,000.00. If the rate drops to the minimum guarantee, and I’ll give you that
number and explain why it’s not that big of a deal, you’ll get all of your money back after five
If the conversation is “How do I guarantee three percent on my money?” the response to that is
“No one’s going guarantee you three percent on your money.” The question is “How do I earn
more than zero?” Then, we talk about what other options are out there.
Male Speaker 1: You don’t lose your principal on that one?
Trey Fairman: You can cancel it whenever you want. In your example, if it’s guaranteed and you
cancel it within year five, then you are going lose some of your principal. Does that make
sense? Was that clear? Let me make one last comment. I don’t think the rate’s going to drop.
Even if it drops from 4.45 to 3.25, you get all your principal back in about 18 months. The
question is, MetLife who’s making one and a half percent on that money, they know when they
drop the rate, the money’s leaving and they need to gather assets, and that’s the only type of
option like that around, so why would they do that? They may drop it. They have a very similar
portfolio that’s been around since 2006, so think about what’s happened in the world since
That portfolio started out at 4.85 and today it’s a 4.5. So, it dropped .35 percent in the worst
financial crisis in modern times.
Male Speaker 2: Is it advisable to buy life insurance within your IRA? Does that make
Trey Fairman: No, it’s not advisable because it’s illegal. You can’t do that.
Male Speaker 2: You can’t do that?
Trey Fairman: No.
Male Speaker 3: Can you repeat the question?
Trey Fairman: The question was, is it advisable to buy life insurance within your IRA? The
answer is, it’s not advisable because you can’t do it. It’s illegal.
Male Speaker 4: Even if that was allowed, it’s a bad idea. You’re taking an asset you
receive income tax-free and turning it into something that’s 100 percent ordinary income and
Trey Fairman: Exactly. A lot of these are themes. Let’s make a comment on that. What does the
IRS say? Remember the stats from earlier. Over 73 percent of you have over $1 million. Doug’s
stat was, there is $7.2 trillion in IRAs. We need revenue. The Baby Boomers are retiring. All this
money in qualified plans. The IRS is not super excited about IRAs that you manage properly that
balloon to these values that we leave to our kids. There was a tax court case a year ago about
stretch IRA planning. In theory, if we do IRA planning right, you can spend all the money. If you
don’t, your spouse can spend all the money. If he or she doesn’t, your kids can spend all the
If we use life insurance, like Doug was showing us, we can make the number much bigger and
tax-free. We can do all that great stuff. There are rules we have to follow, and the IRA rules are
somewhat onerous. I think Doug pointed out, if you don’t take the money out when you’re
supposed to, you have to pay a 50 percent penalty. Then, Paul’s comment, life insurance is
always income tax-free. No one likes to pay tax, but I say, let’s pay tax on the small number,
disability insurance premium, where we get the big number tax-free. Yes?
Male Speaker 5: The presentations today were very good about insurance. I went to med
school like everyone else. When I hear you talk about insurance, it’s a contract to get paid in
the future. So, I give you money, and you promise to pay me in the future the death benefit or I
can pull it out after X number of years. It smells to me just like an annuity that I’m giving you a
lump sum of money, and you’re giving me a stream of income. What is the difference besides
the death benefit between the two? It just seems like it smells the same.
Trey Fairman: That’s it. The easiest thing about life insurance is leverage. Take an example of
$100,000.00. You say, “I don’t need the money. It’s for my wife.” I’d say, “You can guarantee
$400,000.00 of death benefit for your wife.” If you said, “What happens if I need the
$100,000.00 next year?” I would say, “Because of surrender charges, it’s not worth
$100,000.00, but it goes from $100,000.00 to $400,000.00 overnight.” If you keep it in that
annuity, and in today’s world, fixed annuities are growing at two percent, it’s going grow slowly
over time. It’s much more liquid for you, but it will never reach $400,000.00 after tax in your
lifetime. The only difference is exactly what you just said.
Male Speaker 6: There’s one other difference, if I heard the question correctly. If you’re
taking income from a life insurance policy, it’s income tax-free. If you’re taking income from an
annuity, it’s ordinary income tax.
Male Speaker 5: But there’s a wait. So, it’s just a time difference.
Male Speaker 6: It’s tax-free versus taxable.
Male Speaker 7: Right, but you can’t get the life insurance until after X number of years.
Male Speaker 8: We can’t hear the conversation up here, guys.
Trey Fairman: The question was, can we take money out of a life insurance policy for a fixed
number of years like we can an annuity? The answer is you can. It’s not going be guaranteed
like an annuity. In today’s world, annuities are great because you can give a lump sum to an
insurance company and say, “Give me income for the rest of my life.” Big asterisk to that.
Whether my life is a day or 100 years. That’s important when we’re doing income tax planning.
The number that comes out is taxable. If you live too long, it actually becomes taxable. Life
insurance money comes out income tax-free. There are some nuances to it. I’m happy to talk
with you later. It’s not a simple yes or no answer.
There are pluses and minuses to doing both. Life insurance clearly has more drag on it because
it’s got that death benefit growth. Like John said earlier, if we drive that insurance amount
down, we drive the drag down as low as possible. There are some interesting opportunities in
the market today that take taxable money and maybe make it tax-free. I know that’s not a
simple, clear answer, but that’s the best I can give you right now.
Thank you, everyone. I appreciate your time.