The Swiss Army Knife of financial tools
By Bill Boersma
For most of my career I wasn’t a fan of viewing life insurances cash value as an investment. My life in insurance has been in the death benefit world; trust owned insurance for estate tax liquidity, business succession planning, charitable planning, family income, etc. I was never impressed when the traditional whole life agents touted cash value. I still don’t, though I’m not saying it’s inappropriate. My problem with it was largely in the seemingly constant misrepresentation.
Focusing on death benefit needs kept me from paying much attention to it, but some years ago I started viewing it from a different perspective; can cash value focused life insurance be a meaningful part of an estate planning solution?
An Example
Let’s look at a client. This is a highly successful couple in their fifties living in California. Let’s say they’re currently worth $50 million. If I assume an estate growth rate dramatically less than they’ve actually realized, they’ll be worth hundreds of millions easily. Assuming 8% at joint life expectancy, the number is a billion dollars.
They have multiple goals, accumulation planning, income tax planning, life insurance protection, estate planning, estate tax liquidity and charitable planning. How does life insurance fit as a potential solution to each of these goals?
I’m going to lay out a typical planning idea consisting of an irrevocable trust and a couple of SLATs and then connect the dots. We’ll also assume $250,000 in annual gifting, which is more than easily doable indefinitely for this couple. Of course, this all has to mesh with annual and lifetime gift tax exclusions relative to donors and the potential number of beneficiaries, but for simplicity’s sake, we’ll assume this all shakes out. Finally, we’ll review potential drawbacks and what to keep in mind.
Estate Planning
First, what does gifting $250,000 annually accomplish? Relative to estate planning, this is reducing their estate by roughly $100 million at death. Of course, there’s a plethora of additional planning ideas they can implement, and they are, but just this gifting is reducing estate taxes by tens of millions of dollars.
Attention is important to make sure there are no incidents of ownership that would bring the death benefit back into the estate for tax purposes. Competent legal council is important.
Estate Planning Liquidity
In this particular example the gifted money is designated for a policy on the husband. The policy is a maximum funded, minimum death benefit variable universal life (VUL) policy that will be invested in diversified growth and aggressive growth sub-account investment options. At an assumed return hundred of basis points less than the historical S&P 500 return, we’re looking at a $100 million income tax and estate tax free death benefit in the trust someday. Now, not only do we have $100 million out of the estate that reduces estate taxes, but we also have $100 million of liquidity available to pay estate taxes.
Market performance can affect death benefit, and that’s exactly the goal during much of the insured’s life, but sub-account reallocation at older ages may be in order to minimize volatility as life expectancy approaches.
Accumulation Planning
Even though this couple is remarkably successful and more than likely will continue to be, they are still paying attention to accumulation planning. They have business assets, qualified plans, traditional investments and real estate assets. Of course, being California residents in the top tax bracket, many of their decisions are built around income tax planning. The $250,000 gift going into a properly structured, very efficient securities-based life insurance policy is not money “given up” for insurance, it’s money repositioned into a trust that is still accessible while being out of the estate for estate tax purposes.
The cash value invested in the sub-accounts is subject to market performance and the policy must be managed like any investment. Poor market performance can reduce the policy’s value, but if it’s built like it should be, it would take severe historical anomalies to threaten the viability of the policy.
Of course, there are policy expenses built into life insurance that traditional investments don’t have. This is expanded on next.
Income Tax Planning
Appropriately, they are concerned with the cost structure of the life insurance. An inherent feature of life insurance cash value is the tax efficiency. A thorough analysis shows that when built right, the policy expense drag on the life insurance is less than the tax drag would be on the same investments not in the life insurance policy. The investments in the policy can be rebalanced and repositioned without tax, as in a qualified plan. Additionally, they can access this money tax free without realizing the typical tax on gains when liquidating.
There’s a need to be careful the policy doesn’t become a Modified Endowment Contract that would threaten the tax benefits. If cash value is accessed by policy loans, these loans are generally tax free, but if the policy lapses or is surrendered with loans outstanding, the loan amount may be treated as taxable income. Policy management can mitigate these risks.
If this ends up like a vast majority of situations, they’ll never need and never touch the money, but there’s a sense of security knowing it’s there, making it much easier to transfer it to the trust. Accumulation planning and income tax planning… check.
Life Insurance
They have so many irons in the fire and there’s still a desire to have good old fashioned cash for the spouse if the husband dies, even though the spouse is very active in the companies and an income earner. The insurance planning need is clearly accomplished by the policy that is also offering estate tax planning, liquidity, accumulation and income tax planning benefits.
This is a good time to note that the architecture of an efficient, well designed and properly managed variable life policy would be the antithesis of what was too often seen in the late nineties. At that time, VUL policies were too often built thinly funded based on unrealistic assumptions in a roaring stock market. They were inappropriately spreadsheeted for competitive purposes which is the opposite of how these products are best designed to work.
Charity
This couple is very charitable inclined and has already put at least one charitable trust in place for income tax, estate planning and charitable purposes. What does the trust owned policy add to the equation? Having the hundred million of insurance proceeds in the trust allows for leaving more assets in the estate to charity. Maybe they’ll leave a hundred million dollars, or some percentage or some multiple of that to a family foundation their kids can be involved with and manage.
I’ve always liked the term “Total Wealth Control.” For sincerely large estates, you can’t really pass the entire amount to your heirs without losing a portion to estate taxes or incorporating significant charitable bequests, even if you wanted to. However, with the right planning you can set it up so your family controls your entire net worth and sees that it’s utilized in line with your goals and values.
As with most investments, the ultimate value of the policy and its future benefits can be uncertain, making it difficult to quantify the charitable impact upfront. Nonetheless, the interplay between charity and life insurance planning offers a multitude of opportunities.
Summary
I intentionally postured this in a bit of an over the top way, but it’s also completely legit. We all understand that life insurance has a certain reputation and being so involved in the litigation support and expert witness side of the industry I regularly see the unsavory characters and resulting train wrecks. Try as I might, I can’t think of an industry that doesn’t have the same issues on occasion. However, that shouldn’t keep consumers and their advisors from utilizing and implementing the aspects of it that can be of significant benefit.
Once again, check out this list:
- Accumulation Planning
- Income Tax Planning
- Insurance Coverage
- Estate Planning
- Estate Tax Liquidity
- Charitable Planning
That’s really quite impressive. Name me any other financial product that can accomplish this. A flexible product mated to some basic planning tools and strategies and just maybe you can have your cake and eat it too. Maybe it’s time to bring your team together to bring the plan to the next level. That’s precisely what this couple did. The attorney, CPA, additional tax counsel, financial advisor, trust company, and me, the insurance professional, all worked together to integrate multiple aspects of estate, gift, income tax, charity, investment and insurance planning. Sniff… it was beautiful.
Bill Boersma is a CLU, AEP and LIC and the founder and owner of OC Consulting Group. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info or email at bill@oc-lic.com or call at 616-456-1000.
Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Investment Advisory Services offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor. OC Consulting Group and its affiliates are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc.
