If you’re dealing with affluent clients who say they don’t need to include cash-value life insurance in their estate plans because they can do a better job of investing their money, here’s a way to shake them back to reality: the dollar riddle. It shows people that if a dollar doubles each year for the next 20 years, that’s over a million dollars. But if you have to pay capital gains, alternative minimum or even ordinary—state and federal—income taxes on it, 20 years later the investment will only be a fraction of what it could have been worth without taxation.
The dollar riddle goes like this: Ask your client, “If $1 doubles in value each year for 20 years, how much will it be worth in 20 years if you had to pay income tax each year on the gain at the following tax rates?”
a. 0 percent (tax-free)
b. 20 percent (capital gains)
c. 40 percent (state and federal combined income-tax rates).
Give your clients a few minutes to mull over the multiple-choice options. Then show them the answers:
Tell them, “Einstein said the greatest invention of mankind was compound interest. He was wrong—it is compound interest without taxes. Sometimes you can make more money by saving taxes than by making more money.” The riddle leads your clients toward this conclusion: Life insurance can help avoid the erosion of taxation. Cash values grow tax-deferred, and the death benefit is always more than what you paid in premiums, which are generally pennies on the dollar. Properly arranged, the proceeds are income and estate tax free. There is also no market-timing risk—the proceeds are payable at precisely the time the cash will be needed the most—at the death of the insured.
Rob Smith, CLU, ChFC, an agent with Northwestern Mutual, is incoming president of NAIFA-Michigan. For more investment riddles to share with your clients, see "Riddle Me This."