Joe, age 62, plans to retire around age 70. As with many his age, he received an invitation for a free dinner at a nice restaurant Hosted by the financial planner. At the dinner, the planner pitched a "Life Insurance Retirement Plan" (LIRP). The LIRP would take advantage of a feature of the US tax code that allows funds to grow on a tax deferred basis within a life insurance contract. No tax is paid on any of the investment income in the product as long as the funds stay with the insurance company. Profits, if any, are only taxed when taken out of the product. However, loans taken out against an insurance policy are not counted as income as long as the policy stays in force. Joe would be able to get retirement income from the product by "borrowing" against the cash value of his policy. The borrowing reduces his death benefit: When he dies, the accumulated loan amount will be paid out of the death benefit. As life insurance proceeds are generally exempt from federal income tax, there would be no federal income tax on any of the investment income as long as the insurance stays in place. The trick is to not take out so much that the insurance lapses, which would make all of the withdrawn profits immediately taxable and produce a big tax hit. As Joe's assets will be less than the threshold amount for the federal estate tax, he is not worried about estate taxes on the death benefit.

However, the LIRP is loaded with fees and sales charges. Joe doesn't really need or want life insurance, but he is intrigued by the tax breaks. The LIRP allows him to direct the money to be invested in a variety of different investment products, some of which are quite complex. He is wondering whether the tax breaks offered by the vehicle are enough to overcome the costs of the product.

The planner worked out a 46-page "illustration" showing the various fees and expenses. Joe would contribute $75,000 at the beginning of each year for 7 years for a total contribution of S525,000. Starting at the beginning of year 12, he would "borrow" $51,600 each year from the policy for 19 years for total withdrawals of $980,400.

There would still be some kind of death benefit for the heirs after paying off the policy loans, but Joe is not interested in that. Joe is very concerned about the high level of fees and charges and wonders whether the product makes sense for him after fees.

The projection from the planner is based on an assumed rate of return on the underlying investments of 9%. Joe thinks this is a bit aggressive considering the current level of asset prices.

Joe expects to be in a 38% marginal tax bracket due to the high RMDs from his tax deferred retirement plans.

A.) What is the after-tax rate of return Joe will earn on the projected cash flows from the LIRP product? (Note that there are note that there are no taxes on the distribution from the product. IGNORE THE DEATH BENEFIT.)

B.) Joe's alternative would be to invest the money in a taxable account following a similar investment strategy as he would in the LIRP. What pre-tax rate of return would JOE have to earn to match the projected return from the LIRP product? (Assume that the gains each year are taxed at Joes marginal tax rate of 38%)