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Single-Premium Insured Deposits

QUESTION: I have nearly $100,000 left over after I paid taxes on a lump-sum distribution from my employer. I decided to pay the tax now because I qualified for 10-year averaging and the resulting lower rates. Now I’m hunting around for a good place to put my money. One thing I’ve been hearing about is a single-premium universal life insurance policy. Can you tell me more about it?--L. R.

ANSWER: This investment vehicle, also called a single-premium insured deposit, is a hybrid of a whole-life insurance policy, a certificate of deposit and a tax-free source of income. Some financial advisers consider it ideal for investors in your situation. Here’s why. Say you take the full $100,000--you’ve paid Uncle Sam already, so you can use the money in as many ways as you wish--and buy a single-premium insured deposit. What you have is the equivalent of a $100,000 investment earning tax-free compounded interest and whole-life insurance coverage valued at between $101,000 and $500,000, depending on your age. The older you are, the less insurance coverage this policy provides, a point you should ask your financial adviser or the policy salesman to cover carefully before you invest.

Perhaps the biggest plus is that you can use these policies as a source of tax-free income and not have to worry, as you do with the tax-free income from municipal bonds, about losing part of your principal as interest rates fluctuate.

Most of these single-premium policies are set up so that the owner, after the first year, can withdraw the interest earned on the deposit in the form of a low-interest loan from the insurance carrier. In your case, you would have the right to borrow at least $10,000 a year after the first year for the rest of your life, assuming a yield of between 10% and 11%, which is typical at the moment.

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The borrowings would be tax-free and you wouldn’t be dipping into your principal, a concern for many retirees who want to ensure that a spouse or other heir receives a certain amount upon the policyholder’s death.

When you’re shopping around, you should insist that the advisers or sales people pitching various investments run through an example that is pertinent to your situation. That example should show you precisely how much yearly tax-free income you could expect at today’s yields after accounting for the money that you pay the insurer for the right to borrow back your interest.

Be sure to ask how that net amount compares to other tax-free investments, again at yields currently available to you. And don’t forget to compare how the 10% to 11% tax-free yields stack up against other offerings on a $100,000 investment.

Obviously, the longer you leave the principal untouched, the more you can withdraw yearly thereafter. If you wait 10 years and then withdraw your interest every year until your death, you could lend yourself in the neighborhood of $27,000 a year for the rest of your life without touching your principal.

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These policies also permit the owners to borrow between 90% and 95% of the principal, again without triggering a tax bill. Nor do your heirs, upon inheriting the accrued interest, principal and death benefits, pay any income tax on this money, although there may be an estate tax liability.

Also be sure to inquire about commission fees and surrender charges. Some insurers penalize you if you cash out the policy any time during the first 10 years. And some, such as Fireman’s Fund, give you a year to make up your mind whether you’re happy with the investment. If not, you can pack up your full $100,000 and go elsewhere at no penalty.

Single-premium insured deposits are available for as little as $5,000 from insurance companies and stockbrokers.

Q: I have a creative design business and rely on upwardly mobile yuppies and affluent people for most of my business. To drum up business, I have joined several civic groups and social clubs, hangouts for these types of people. I can trace several accounts and orders directly to my memberships. Are my club dues a legitimate business deduction?--P. K. P.

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A: You have a shot at a deduction if you can prove a direct link between your membership in the clubs and the business you have obtained. And that isn’t always as easy as it seems.

The Research Institute of America, a tax-research group, points to a New Orleans insurance agent who made much the same argument in deducting dues to a Mardi Gras carnival club and lost. The man argued to the Internal Revenue Service that his insurance business depends on his ability to meet wealthy people and that the club was an ideal forum.

As its name implies, the club revolves around partying, not business. But its purpose aside, it attracts affluent people with money to spend on his insurance offerings and financial services, the man argued. He attributed $11 million in new life insurance policies to his membership in the club.

But the IRS, and later the tax court, disallowed the deduction on grounds that the case was a classic chicken-or-egg puzzle. There was no proof, both decided, that the membership preceded the business or that he would have been denied the business had he not been a club member.

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Without that proof, the IRS said, the club membership would have to be regarded as a personal expense rather than a business cost and therefore wasn’t tax-deductible.

Q: Several cities have begun charging advance fees for paramedic services. As far as I can tell, these are similar to a medical insurance premium. Does the IRS allow a medical deduction for such fees?--R. F. F.

A: If these fees are actually an advance payment for services rendered by a paramedic, the IRS says they are not deductible. But if they are just another name for an insurance premium, then they are deductible.

Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Business Section, The Times, Times Mirror Square, Los Angeles 90053.

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