It’s September and the end of the year and possible tax law changes regarding estate taxes and gifting are looming large.
In order to take advantage of all or part of the $5,000,000 unified credit allowance before it potentially disappears, many of your clients have been presented very large single premium life insurance proposals . The cynical side of non-insurance advisors look at this as simply another sales strategy and a high pressure one at that. I know this because some of you are calling for advice. I’m not going to opine on the appropriateness of such a strategy for a client situation I know nothing about, but assuming that a given individual or couple has an estate which legitimately warrants a serious discussion about gifting seven figures of assets in order to take advantage of a potentially temporary opportunity, let’s boil it down to the numbers.
For additional context regarding this discussion, I urge you to review my blog posting from February 2011 which is basically a commentary on Richard Harris’s January 2011 Trusts & Estates article Hedging Your Bets; one of the best pieces I have read regarding the use of life insurance death benefit as a portfolio asset. I would also read the Trusts & Estates August 2012 article The Split-Dollar Legacy Trust by Martin Shenkman, Richard Harris and Lawrence Brody regarding potential applications.
So, let’s take out our HP12Cs or other financial calculators and start computing the internal rate of return (IRR) on various life insurance scenarios. Ground rules and assumptions are listed below.
Single Life (Male)
| Age | 50th % LE | Death Benefit | IRR | 20% Tax Equivalent | 40% Tax Equivalent |
|---|---|---|---|---|---|
| 35 | 82 | $10,745,000 | 5.2% | 6.5% | 8.7% |
| 45 | 82 | $7,518,000 | 5.6% | 7.0% | 9.3% |
| 55 | 83 | $5,155,000 | 6.0% | 7.5% | 10% |
| 65 | 85 | $3,294,000 | 6.1% | 7.6% | 10.2% |
| 75 | 89 | $2,115,750 | 5.5% | 6.9% | 9.2% |
Survivor Life (Second to Die)
| Age | 50th % LE | Death Benefit | IRR | 20% Tax Equivalent | 40% Tax Equivalent |
|---|---|---|---|---|---|
| 35/35 | 90 | $18,538,000 | 5.5% | 6.9% | 9.2% |
| 45/45 | 91 | $12,540,000 | 5.7% | 7.1% | 9.5% |
| 55/55 | 92 | $8,357,000 | 5.9% | 7.4% | 9.8% |
| 65/65 | 93 | $5,059,000 | 6.0% | 7.5% | 10% |
| 75/75 | 95 | $2,938,000 | 5.5% | 6.9% | 9.2% |
Given these numbers, I am not going to make a proclamation on whether or not they are poor, mediocre, good or great. The are what they are. But remember, they are net, after tax numbers which are quite conservative. Call this a safety of principal asset if you want, or not, but it will clearly be more conservative than many other portfolio assets and on a risk adjusted, tax adjusted basis, at least deserves a fair shake. Life insurance death benefit also comes in exactly when needed at full face regardless of market conditions. It doesn’t care if it’s 2008 revisited and all investment sectors are dramatically down. It is not affected by jobless numbers or housing starts or the exchange rate to the yen or the euro or national security issues so it is particularly attractive for it’s non-correlated portfolio diversification benefits. Finally, remember it is life insurance so the IRR will likely be higher or lower based on age at death but living 5 or 10 years longer or shorter than actuarial 50th percentile LE will not make as much difference positively or negatively as you might think.
This isn’t a life insurance advertisement as I’m sure some will assume. If that was the case, I could make these numbers look a whole lot better. The bottom line is to get your arms around the numbers and decide if, given the current tax law and your client’s individual situation, does it make sense to layer a bit of this into a bigger plan or not? I hope this is helpful and I look forward to discussing in more detail if you want to pick up the phone and give me a call or shoot me an email.
1. All numbers assume regular preferred non-smoker underwriting rates. For most insurance carriers, this is two or even three levels down, not the best rates available. If a given individual or one half or both halves of a couple is standard or rated, clearly the numbers will change, but often times not by as much as you might imagine and remember that theoretically life expectancy would be in those situations shorter so IRR won’t take much of a hit.
2. All numbers assume a $1,000,000 single pay contribution to the policy. By and large these numbers can be prorated upwards or down.
3. These number are based on traditional or guaranteed universal life policies, not whole life or variable life or indexed UL. Ultimately, products and options could be endless and clients should be presented with alternatives along with upsides and downsides of all. This is a quick glance at the market and only meant as ballpark numbers. I would be happy to run alternate scenarios for those interested.
4. The numbers used are an average of the top handful of major carriers in the life insurance brokerage marketplace and do not represent a given insurance company or even the best rates available.
5. All internal rate of return calculations are based on the insured individual’s 50th percentile actuarial life expectancy (LE) or a couple’s 50th percentile joint life expectancy. 50th percentile life expectancy is the age at which 500 of 1000 individuals in a given class (68 year old male, for example) will be living and 500 will be deceased.
6. Pre-tax equivalent rates of return are based the federal and state capital gains and ordinary income tax rates here in Michigan.
