Originally published on Forbes.com June 8th, 2013
I really hate it when somebody takes a tax hosing, because they bought life insurance. It must happen a lot, because I regularly see Tax Court decisions on it. I have to assume that the published decisions represent the tip of iceberg.
What happens?
From the taxpayer point of view, the typical scenario is that, like a bolt from the blue, the taxpayer receives a 1099 from an insurance company. Their response is WTF. They didn’t get any money from any insurance company. The insurance company, of course, sent a copy to the IRS. The more stubborn among the WTF crowd will take it all the way to Tax Court, where they will, most likely, lose. Even after they lose in Tax Court, they probably still don’t grasp what happened. They are probably mad at the IRS, the insurance company and the Tax Court. I think they are justified in being mad at the insurance company, but the person they should really be mad at is whoever sold them or their employer the original policy, which they might not even remember.
Ask An Insurance Agent
I decided it would be a worthwhile exercise to discuss my view on this with an insurance advisor. I ran it by Charlie Manoog of MSW Financial Partners. Charlie has an interesting perspective, because he started out in the business as a client. He was the third generation of a family plumbing supply business in Worcester. He was the last president and managed the sale.
The story of his family business is rather colorful. His father, Russell, founded what is now known as The Plumbing Museum, but was locally known as the “toilet museum”. After the business sale, the museum relocated to Watertown (Where else ?). When the Piedmont neighborhood, where Manoog Plumbing was located, became the go-to spot for Worcester street prostitution, Russell posted a large sign warning about the dangers of HIV and hepatitis hoping to scare off the johns. Charlie told me that both he and his father, who are Harvard graduates, never quite got as sharp as his grandfather, also a Charlie, who had a sixth grade education. The elder Charles Manoog managed the sale of the most significant four of the original Dead Sea Scrolls on behalf of a Syriac Orthodox Archbishop.
PJR: Charlie, you have looked at those cases, yourself. Do you agree that the taxpayers got a raw deal from somebody?
Charlie: Most of the problems that you highlighted in these cases stemmed from the mishandling of a Tax-deferred Account: cash value life insurance. The account holders were probably not even aware they were creating an account with special provisions afforded and enforced by the IRS. Maybe they simply intended to source another group benefit through their employer. It’s not too big of a leap to see how they could believe that.
Your gut (to feel sorry for them) correctly suggests they may have been misled, but insurance polices don’t mislead people. People mislead people. One might go so far as to say some employee policy holders have been victims of mildly fraudulent sales practices, disguised, but in full view, so to speak, in company benefit lingo. Phrases like “ funding through pay-roll deduction,” “benefit ” and “conveniently offered through your workplace” can be used to camouflage the sophisticated nature of the policies, or to divert attention away from details that need questioning .
PJR: So do you think this is pretty much “caveat emptor“?
Charlie: Employees often feel it’s not their responsibility to monitor or manage their benefits. They choose not to be too concerned about the state of their short and long term disability or health insurance ( unless on claim.) For many, especially at younger ages, these are just annoying bi-weekly deductions that diminish their envelope pay. This apathy , or trust (?), can be fueled by old fashioned paternalistic management ( “go talk to HR, they will take care of that for you..” ). Both the broker and the HR departments, responsible for establishing these life-insurance-at-work programs, sometimes exploit this trust. I suspect the brokers, more so than the HR people, are keenly aware of this. There are many enticing qualities of group life sold through employers, that make it irresistibly attractive to brokers. Group-underwriting , for starters , distances the broker from the insured by eliminating the need for fact-finding and ensures that individual health or financial suitability won’t jeopardize the success of the sale.
PJR: How can the whole thing be better handled?
Charlie: Getting permanent life insurance isn’t meant to be an odious task, but it’s not simple either. What else, worth doing, is? Correctly tailoring cash value life insurance to a policy holder is a highly personalized, border-line nosy, process. If a prospective policy owner doesn’t spend quality face-time with the insurance professional before and after the sale, mistakes and inevitable disappointment will not be far behind. Insurance is an asset class that, like securities or commercial real estate, can be purchased by anyone, but should be managed in cooperation with a professional that you can trust, over the entire holding period.
PJR: Do you see a role for employer provided life insurance ?
Charlie: Life insurance as a group benefit , with the exception of term , is not really a great idea for the buyer with the exception being a Bonus 162 plan for a group of executives. When marketed and managed primarily as a retirement income accumulation vehicle, using cash value insurance as the TD’d account , it can be a huge win-win for all. Such a program is not for the hourly wage earner and, when done well , can be extremely effective and advantageous. Continual participant education similar to that seen with 401k plans, the ability to monitor your personal cash value accounts online, and new policy features like “over-loan protection “ prevent unintentional lapses and unpleasant tax consequences.
PJR: Can agents do a better job of explaining things?
Charlie: People say life insurance is complicated and it’s lack of transparency hampers its popularity. Whole Life, like the polices in your articles , are the mother-ship of complexity , secrecy, and confusion. Many agents use “simplification” and “demystification” of financial services as their taglines, which is a good thing. But oversimplifying is an abuse of customer trust. Putting whole life in the basket of at-work benefits is an opportunity for inappropriate oversimplification. The responsibility to protect employees from those types of programs lies with the employer.
PJR: Tell me a little about your firm.
Charlie: I started my professional life on the client side of the financial services equation. Before I joined Moynihan Advisors in 2006 (now MSW Financial), my wife’s was the broker and ran educational meetings for the 401k plan at our plumbing supply business and my father-in-law handled the insurance. Now I work for small business owners and their key employees looking to make their policies “multi-task.” I show them how to structure modern insurance plans for diversification, accumulation far beyond qualified plan limits, and for succession planning. I think of us as a small, family owned financial services shop. We leverage our affiliation with the preeminent player in our industry, NFP , so we can cater to pretty much everything you can find within a 3 hour drive of our Worcester office. We have to be multi-disciplinary, just like our clients.
You can follow me on twitter @peterreillycpa.