Life Insurance at 100

Different Policies Have Different Features

When it rains it pours. I have multiple cases on my desk now regarding age 100 and/or “endow-ment” issues. Also, recently a Wall Street Journal addressed this same issue.

Historically most policy owners didn’t concern themselves too much about what happens when an insured individual turns 100 years old. This is partly because most people didn’t expect to live to 100 and partly because people didn’t know there was anything to concern themselves with. However, it seems to be on people’s minds more often lately.

Current Mindset

For a recent insurance portfolio I helped to construct, the decision was made to go with a blend-ed portfolio of guaranteed universal life insurance (GUL) and an indexed policy (IUL). The GUL was guaranteed for life and the IUL was guaranteed past life expectancy but not for life. How-ever, it was critically important to the trustee to extend the guarantees as the insured’s father lived into his nineties and his mother is still living in her late nineties. Even a guarantee to age 105 with projections at reasonable rates lasting forever wasn’t enough so we went further. I get it, especially when you are the trustee.

Whole Life at 100

The CFO of a family owned company recently engaged my services because the whole life policies owned by the children on the life of the family matriarch endow at age 100. Mom is turning 100 later this year. What does this mean? If the policy doesn’t have an extended maturity option (and this one doesn’t) the policy will mature and pay out at age 100. In a whole life policy, the cash value and the death benefit equal each other at age 100 so what’s the big issue? Taxes. At death the entire amount is tax free but a policy which pays out during life at policy maturity is taxable above basis. Most of the cash value is over basis.

If I make up a scenario and assume the cash value is $1,000,000 and the basis is $400,000 then $600,000 is taxable with a tax likely in excess of $200,000. We still have at least three quarters of the money available. This is clearly a disappointment but at least all is not lost.

However, in the above referenced situation, the $1,000,000 policy was sold on a short pay for 10 years and for the past 20 years the contract has been auto loaning itself the premium (unbeknownst to the policy owner which is par for the course). So? The loan is now $1,400,000. Gross cash value is $1,792,000. Basis is $800,000. This leaves about $1,000,000 taxable at ordinary rates. Taxes in this situation will be roughly $400,000 to be paid from the net cash value of $392,000,000 leaving the family with nothing. Yes, the entire forgiven loan is considered taxable income. If she passed away, the loan is paid off by the death benefit leaving them about a $600,000 death benefit. In and of itself, that would be disappointing as they purchased a $1,000,000 death benefit which they conservatively expected to grow over time. Actually, it did grow but the loan grew even faster which ate into the expected death benefit.

Earlier this week an attorney emailed me a statement on another whole life policy in a similar situation. When the policy lapses the taxes will far exceed the net cash value and the policy owner will have to come out of pocket to pay off the IRS for the taxes on the phantom gain.

Universal Life at Maturity

A case from a CPA involved a Universal Life contract. UL polices don’t technically endow in the sense that whole life policies do but they can have their own issues. There are multiple genera-tions of UL contracts and you can be pretty much assured your clients do not know which one they have. Some UL policies pay out the cash value at policy maturity and sometimes that is before age 100. If your client has a $5,000,000 policy and they are lucky enough to reach age 100 and the cash value is $500,000, they get a check for $500,000 with anything over basis taxed at ordinary rates.

Policies a generation newer take the cash value at maturity and extend it as the new death bene-fit. If your client’s $5,000,000 policy has $500,000 of cash value at age 100 then the policy will move forward with a $500,000 death benefit. However, due to a 35 year declining interest rate market, most of these policies are woefully underperforming and many will not hit age 100 with-out additional funding. The problem is, funding an underfunded policy to have cash value equal the death benefit at policy maturity is generally an untenable exercise. And if you do dramatical-ly increase the funding and the insured passes away at 95, the death benefit is no higher and all of the dollars are wasted. These are tough decisions.

With some policies, at least if you made it to 100 then the policy stayed in force until death, re-gardless of age. Many of them also did not have premiums and expenses after age 100 so once you hit 100 you were home free. Nowadays, policy maturity is more likely age 120 or beyond but you have to choose how long to fund it. Do you automatically fund for life instead of age 110? If the premium is negligibly different then of course you do. Some policies have a mean-ingful spread in premium for guarantees for life, to age 110, 105, 100, etc. Where is your com-fort level?

Decisions Need to be Made

These are damned if you do, damned if you don’t scenarios at times. I was working with the family of a 90 year old woman with a $10,000,000 policy with a few million of cash value. The existing cash value projected to hold the policy for 5 years then the contract would lapse. This means the cash value is dropping by hundreds of thousands of dollars a year. To hold the policy to age 100 would take a low seven figures of premium but if she hit 100 it would still all be lost. Holding the full death benefit beyond 100 would take millions more. Do you cut and run today, taking the remaining cash value and saving millions in premiums when she could pass away by Christmas and you lose the $10,000,000 in tax free death benefit? Paying the entire required premium for the full death benefit to persist beyond age 100 would leave you a relatively small spread between payments and payoff. Objective analysis can help with these decisions.

Regarding extended maturity options, some contracts have them but they are not automatically included and the policy owner has to overtly request them. Sometimes this is purportedly a letter which will be sent to the policy owner 30-90 days prior to maturity. This is insane! I have every bill in my life on auto pay because, though I am generally a responsible guy, my life is compli-cated enough that there can be no expectation that I will remember everything every month. Now imagine throwing in a literal once-in-a- lifetime decision that you were not expecting, do not understand and will probably not address in time.

I recently had such a case on an individual in her eighties. I told her son to write the letter re-questing the extension now, file a copy of it, and send the same letter every five years so if the policy owner doesn’t notice and act during the short window there will be a paper trail of intent and directive. I can’t guarantee what will happen but it certainly can’t hurt.

Bottom Line

Your clients need to understand things that they most definitely do not understand at this mo-ment. They will be blindsided without your heads up. Help them however you can.

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