In early June, an Investment Advisor reader e-mailed me a response to my June column on legacy loans. Here's his analysis, and why, while mathematically accurate, I feel it misses the reason why these new life insurance alternatives can be beneficial for policy holders.
Our reader offered this example: "An insured has a $200,000 life insurance policy, with a premium of $200 per month. If he gets 90% of the death benefit ($180,000) as a legacy loan, at a guaranteed 9% interest rate, he pays the lender $16,200 + $2,400, or $18,600 a year until he dies. If he lives another 10 years, that's $186,000 to cover the $180,000 loan. If he didn't spend all the money at once, he would be earning interest on a portion of it, but not 9% for an account with liquidity and low risk. I was looking forward to a legacy loan, but my example didn't offer any good news. I hope I made a mistake."
As far as I can tell, he didn't make any mistakes, but his conclusion still misses the mark. Since the interest is already factored into his $186,000 payback figure, if the insured earned only $6,000 after taxes over ten years, he'd break even on the transaction, while having the use of the $180,000 for all that time, not a bad deal at all. Or put another way, if he invested the $180,000 at even a moderate rate compounding over ten years, he'd come out substantially ahead. So, it's hard to argue that this isn't a "good deal."
But as I said in my intro, all this really misses the point. The advantage of legacy loans isn't to get your hands on your own death benefit to make yourself richer. It gives insureds the option of giving a portion of their future death benefit to their beneficiaries, who may have a greater need for that money today--under terms that are far better than traditional insurance loans and for much higher amounts than viatical settlements typically offer.
Even if you just use the loan on yourself (say to pay for necessary surgery), you still get more of your death benefit at a much better rate. Call me crazy, but that's pretty good news.
