A Question About Safe Money

A client recently asked this question:

I’ve got some money I’d like to leave to my grandkids. I want it to grow, but I’m not comfortable putting it at risk in the market. Meanwhile, safer investments like CDs seem like they’re barely keeping up with inflation. Do you have any suggestions?

It’s a classic case of competing demands. We want the growth that comes with risk, AND we want the safety that comes with conservative investing. Just the other day I had a guy tell me (smirking), “I just want steady ten percent returns, with no risk of loss.” 

(Right. And I want delicious ice cream that makes me lose weight.)

Investing doesn’t work that way. We can’t have massive gains and guaranteed safety too. But there may be a middle ground that’s attractive.

If you’re a CD person, you’ve probably been bombarded with sales pitches for tax-deferred annuities. These are accounts set up by insurance companies. You can set aside money for retirement, and one day it can be turned into a stream of lifetime income. 

The problem with most annuities? Most have large surrender fees. If you change your mind, or suddenly need your cash…or if interest rates jump and you want to move your money back into a CD with a better yield, you can’t do it the first few years without paying substantial penalties. It is common for annuity surrender penalties to last seven or more years. Some may be shorter, many are longer.

While most folks have heard of tax-deferred annuities, not many know about the lowly modified endowment contract (MEC). A MEC is also an insurance company instrument. It’s essentially a whole life policy stuffed with cash.

Because insurance companies don’t have the short-term liquidity requirements of a bank, they can often make longer-term investments, which in turn pay a slightly higher yield. This can translate into a higher return than one would get with a CD. (Obviously, the details on a MEC can vary, or change quickly, so you need to talk with an expert and get all the facts before doing anything.)

Like an annuity, MEC funds are tax deferred while left in the contract. And there is a federal government tax penalty for early withdrawal if you take money out before age 59 and a half. For that reason, a MEC is typically most appropriate for folks over that age.

Unlike an annuity, with a MEC the ability to get to all of your money comes much quicker, as in the second year. 

There is also a death benefit attached, so that proceeds pass income tax free to your heirs. Because of the death benefit, you have to go through a physical underwriting process to qualify for a MEC. My experience, however, is that most reasonably healthy older adults qualify. Again, talk to a trusted, licensed agent to learn all details.

Here’s an example of how a MEC can work. Suppose a reasonably healthy 65-year-old man puts $100,000 into a MEC. If the man died the day after the contract was in force, his beneficiaries would receive $175,000. 

Or, if he changed his mind, he could cancel the contract and get back his $100,000 plus some interest by the end of the second year. If he let the money grow and reinvested the dividends, his $100,000 would grow to about $150,000 ten years later, assuming current dividend rates. That’s about a 4% annual rate of return, with no taxation and no market risk. And the death benefit, according to current dividend yields, would have grown to $220,000 in the tenth year. Dividends, of course, are not guaranteed.

The same $100,000 placed in a 5-year CD might get close to 0%…or as high as 4.5%, depending on which bank you use. That is a huge spread, but that’s the rising interest rate environment we’re in right now. Penalties for early withdrawal vary from bank to bank.

MECs are more trouble to set up than CDs. They aren’t right for everyone. But for a long-term saver, looking to maximize returns for you and your loved ones, a MEC is certainly worth investigating.

If you’re like most people, when it comes to things like MECs, you’re not even sure what questions to ask! No worries. I’ve already done that for you. Email me at bmoore@argentadvisors.com and I’ll send you my free list of “30-Something Retirement Questions for People Who are 60-Something.”

Argent Advisors, Inc. is an SEC-registered investment adviser. A copy of our current written disclosure statement discussing our advisory services and fees is available upon request. Please See Important Disclosure Information here.

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