A Caution on Life Insurance TSAs

By Bob Moeller
WEAC Member Benefits

October 2003

Financial Planning Seminars
Achieving Financial Independence

Members who hold tax-sheltered annuities with life insurance companies and are considering transferring them once they can do so with no penalty should pay very careful attention to the actual life insurance provisions in the tax-sheltered annuity. You may benefit by transferring all but just a small amount as the penalties abate. Here’s how it might work:

Most life insurance company TSAs have, as part of the policy, a provision that you will receive some death benefit guarantee if you die. It is not unusual that this benefit is a guarantee that you will receive at least as much as you put in if you die. For that guarantee, you typically pay more than 1% of your variable account value each year. As a general rule, it is simply an added expense – you are buying life insurance you will never need.

For example, let’s say over the years you invested $12,000 into a tax-sheltered annuity, chose your investments, and they are now worth $15,000. You are paying a mortality and expense charge of about 1.2% to guarantee that if you die you will get back at least $12,000. Of course, in this example you would get your account value if you died, so the insurance is worthless. But you are still paying 1.2% of your account value every year for it.

Now, let’s say your account dips to $9,000 in value. If you die, the insurance provides you with a guarantee of $12,000 (remember, that’s only if you die), so indeed the insurance has some value now. Rarely is the value worth as much as you are paying for it, but still it is a value. In this example you are paying 1.2% of your account value, or $108 to buy $3,000 worth of insurance. When your account was worth $12,000, you were paying $144 to buy insurance worth nothing.

So, here is your chance to get some real value in the insurance. A TSA frequently has a provision that your life insurance value is the total of the money you put in less any withdrawals. Let’s say you have invested $60,000 into your annuity over the years. Once it was worth more than $90,000, but because of market declines, it is now worth only $40,000.

You are disgusted with the product and the fees you are paying so you have concluded you want to transfer the funds elsewhere. First, check the life insurance provisions. Typically, your life insurance is guaranteeing that if you die, you will get back at least your $60,000 investment less any withdrawals you make. In this example, you would not transfer or roll over the full $40,000. Rather, you transfer maybe $39,000, leaving $1,000 in the TSA. You now have life insurance of $60,000 invested less $39,000 taken out or $21,000 on your balance of $1,000. Your 1.2% annual charge is $12 for life insurance of $21,000. Make sure you check if there is a minimum you have to leave behind. If you work this right you can create permanent life insurance paying $21,000 when you die for an annual cost of $12.

Your TSA agent from the life insurance company may try to sell you a “new” policy to take advantage of this very tactic. The new deal will, of course, include a nice commission for the agent and begin a whole new penalty schedule for withdrawals for you. Don’t do it. (The agent quite possibly has been warned by the company not to initiate the idea).

Please note I do not recommend life insurance company TSAs mainly because their annual fees are too high. Those fees always include “mortality (life insurance) and expense” fees. But at least if you are going to remove your funds from those high fees, see if you can get some advantage for the many years you paid too much.

On another subject related to being taken advantage of ...

If you have mutual funds you purchased through Morgan Stanley, you might want to go to the library and read the article on page C1 of the May 22, 2003, Wall Street Journal. It covers how some of their “in-house” funds may be pushed because the salespeople get a bigger reward, even though those funds might not be in the best interests of the investor. My suggestion still holds: Learn a little about your own money and investments and pick your own no-load mutual funds. I specifically favor Vanguard, T. Rowe Price, and the no-load Fidelity funds. Make sure you understand what annual fees are charged.

Posted October 1, 2003