Simply put, it is a tax plan where small business owners are allowed to take a 20 percent to 40 percent deduction through their business to purchase an individually owned cash-value life (CLV) insurance policy. If you just read the above paragraph, you’d think that a Section 79 Plan is the nirvana of plans (a tax deductible way to buy CVL insurance). However, when you break down the math and the sales pitch, you’ll know why I despise these plans.
Group underwriting for businesses with fewer than 10 employees For businesses with fewer than 10 employees, the law prohibits full medical underwriting of the policies that are issued (“group” underwriting is required, which is much more risky for an insurance company). Amazingly, one of the insurance companies offering these plans doesn’t have the ability to issue non-medically underwritten policies. This is laughable and pathetic all at the same time. Why are the finances of Section 79 Plans so marginal? Section 79 Plans are up to 40 percent deductible because the life insurance policy purchased is a crummy policy by design. That’s right, by design, the policy is a terrible cash accumulator. The better the policy, the less the deduction. A good policy, Retirement Life(TM), for example, would receive only a 5 percent to 8 percent deduction through the plan.
Converting the crummy policy after year five Section 79 Plans are funded into a crummy cash accumulating policy for five years. Then, the client is typically shown how the policy can be converted to a variable life policy or EIUL policy earning 9 percent annually going forward. Besides that, this is not a conservative example, the numbers are financially marginal even assuming a 9 percent rate of return. Why are so many agents trying to sell Section 79 Plans? This is what really moved me to write this article?
Agents are pitching Section 79 Plans to clients for two simple reasons:
- Many small business clients will buy any plan that is “deductible” because they so despise paying income taxes,
- Insurance advisors want to sell life insurance.
This brings up an interesting issue. If the plan is marginal from a wealth-building standpoint, then why are agents selling it? Again, there are two reasons:
1) Most advisors have not broken down the math so they can come to a correct conclusion, which is that the plans are not worth implementing from a pure financial standpoint.
2) Some advisors know the plan is marginal from a financial standpoint and don’t care because they know they can still sell it to business owners who are looking for deductions.
The first reason is somewhat excusable (or was, before you knew the truth). The second reason is what helps gives life insurance agents a bad reputation. Clients would be better off paying tax on their money and funding a “good” EIUL policy for wealth building. It sounds crazy, but it’s true. The math does not lie. Clients would be better off paying tax on their money and taking it home to buy a “good” cash accumulating policy.