Life Insurance Policies

Life Insurance Policies

Do you own life insurance? If the answer is ‘yes’, the information that follows is must reading.

“Analyze Your Life Insurance”: A Boring Subject, but the Exciting Tax-Free, Wealth-Creation Results Make It Worthwhile… Big Time.

Yes, it’s true: If you’re looking for a boring subject… Analyzing Life Insurance probably leads the parade. Yet, in the real-life world of dollar-saving and dollar-producing results that same — Analyzing Life Insurance — subject unquestionably leads all other tax-free wealth creation opportunities.

IT’S A FACT

Almost everyone who takes the actions recommended here — “Analyze Your Life Insurance” — will create significant additional tax-free wealth for their family with a minimum of effort (and usually without cost)

Read on. You won’t be bored.

Why Analyzing Your Existing Insurance is a Sure Winner

Here’s the Typical Scenario

You have a portfolio of life insurance on your life. Some policies have been in existence for 15 or 20 years; some new; some older. Ownership is helter skelter: some are policies owned by you. Some by a trust. Maybe your business. Or maybe other owners. When you die, the IRS will usually get more cash out of the policy proceeds than your family.

Here Are the Typical Objectives

  1. Increase the amount of your death benefit without increasing your premium cost.
  2. Eliminate your potential tax cost — income and estate taxes — of the insurance proceeds.

No matter what you read here or anywhere else, there is no substitute for working with an experienced, knowledgeable and honest insurance consultant. Of course, the more insurance knowledge you have, the better off you will be, and the better you will be able to determine if, in fact, you are working with the “right” insurance consultant.

Call us “snobs” if you want but, unless the client insists, we refuse to work with an insurance consultant who does not have at least these three attributes: experience, knowledge and honesty (which must include integrity). Yet, we’ll spend hours teaching young insurance consultants who we sense are honest but need more knowledge and experience (but we don’t want them practicing on our clients).

Typical Common and Costly Life Insurance Mistakes

First the brutal facts. Over the years we have analyzed thousands of life insurance portfolios for our clients. In nine out of ten consulting cases that come to my office, we find there is either not enough life insurance coverage or there is too much coverage (someone just plain goofed when analyzing the need). Other common and costly insurance errors are:

  • The wrong person or entity (usually a corporation) owns the insurance.
  • The wrong person (usually the spouse) or entity (usually a corporation) is the beneficiary.
  • The type of policy is not appropriate; often just plain wrong.
  • The policy is not properly funded.
  • The premiums are too high for the type and amount of coverage.
  • The insurance proceeds will be subject to taxes (income or estate; often both), a tax problem that usually can be easily corrected.

This is a big deal. We are talking big money. Typically, the IRS gets 50 cents to 55 cents out of every life insurance dollar. Imagine owning a $1 million policy, and the IRS gets $550,000, but your family gets only $450,000. It happens all the time. A needless tax travesty.

Let’s review the three biggest mistakes people make concerning life insurance:

  • Mistake #1. A corporation should never own insurance on the life of a shareholder. Why?…The trouble starts as soon as the shareholder dies: The policy proceeds are subject to the claims of corporate creditors. Worse yet, if a C corporation, the proceeds can be subject to the alternative minimum tax (AMT) — which can steal up to 20 percent of the proceeds — and the net proceeds (after the AMT) can only get into the hands of your family by paying a second tax via a taxable dividend (OUCH!). If an S corporation, the proceeds (although not subject to the AMT) are locked in the corporation and can only be paid out tax-free if all old C corporation surplus is first paid out as a dividend (a lousy and tax-expensive idea).
  • Mistake #2. The life insurance policy is owned by you or your spouse. You just guaranteed the IRS a big payday.
  • Mistake #3. For married couples age 50 or over, the husband has single life coverage, but what is needed is second-to-die coverage. Typically, your second-to-die premium is about 40 percent lower. In one case, we cut the premium cost from $28,000 per year to $18,000 per year and raised the death benefit from $2 million to $2.7 million. The client loved it.

Some Real-Life Examples

A bit about the examples — taken from our private consulting files — that follow: In one case the person insured is only Joe, in another case, only Mary. If second-to-die insurance is involved both Joe and Mary are insured. In all cases, Joe is married to Mary. Net worth is for the combined assets (excluding insurance) of Joe and Mary.

Example #1: Mary (age 73) is the insured. Joe is uninsurable. Net worth: $1.2 million.

Mary’s original policy had an annual premium of $12,036 for a $350,000 death benefit. The cash surrender value (CSV) was $11,294.

Our Network insurance consultant’s approach: discovered that a subsidiary insurance company (of the company that carried the $350,000 policy) would issue a new policy with a death benefit of $578,897 for the same $12,036 premium. The CSV immediately went up to $32,881 (instead of $11,294 for the old policy).

Example #2: Joe (71) and Mary (69) are the insureds. Net worth: $4.3 million.

Joe and Mary had a second-to-die policy: death benefit $1.1 million; annual premium $22,645; and CSV $268,000.

Our Network insurance consultant’s approach: Created a Premium Financing Plan using the $268,000 of CSV as collateral for a loan to accomplish a four-step plan: (1) keep the old policy; (2) buy an additional (new) second-to-die policy; (3) combining the old and new policies raised the net death benefits to $1.9 million with a new annual premium cost of $55,645; and (4) (But be amazed by step number 4) every year the premium will be paid by a loan, so the cash outlay for Joe and Mary will be zero. Interest on the loan will be paid by additional loans. The loan will be paid in full (after both Joe and Mary die) out of the policy death benefits.

The final results: the net death benefits (after paying off the loan) will always be $1.9 million or more. And neither Joe nor Mary will ever spend one-out-of-pocket penny for premiums.

Example #3: Joe (70) is the insured. Mary is uninsurable. Net worth: $8.4 million.

Joe was paying $63,332 for a $4 million 10-year term policy with eight years left to the term.

Our Network insurance consultant’s approach: Had us create a SUBTRUST as part of Joe’s 401(k). We rolled an IRA into Joe’s 401(k) account, which increased his account balance to $1.95 million. The SUBTRUST bought and will pay the premiums for a $2.7 million Universal Life policy on Joe’s life.

Next, we created an irrevocable life insurance trust (ILIT) to purchase $1.8 million of additional insurance. Joe will gift the $59,040 annual premiums to the ILIT. In summary: Joe lowered his out-of-pocket premiums cost from $63,332 to $59,040, yet increased the death benefit by $.5 million to $4.5 million. Of even greater importance, Joe guaranteed his family $4.5 million of tax-free death benefits whether he lives for two days or two decades. (Note: If Joe would have survived the eight-year balance of the term policy, not only would the premium dollars have been wasted, but the death benefit would have become zero).

Example #4: Joe (50) is the insured. Also Joe and Mary (44) are the insured for a second-to-die policy. Net worth $33.5 million (including a business worth $5.5 million that enjoys 10 to 15 percent growth per year).

Joe had a portfolio (six policies) of insurance on his life: total death benefits of $1.7 million; CSV of $187,000 and an annual premium cost of $19,800.

Our Network insurance consultant’s approach: This tactic is called “new-policy premium financing.” Joe had the necessary collateral (cash, stocks and bonds) to do the following: (1) Have an Irrevocable Life Insurance Trust (ILIT) buy $4 million of insurance on Joe’s life; (2) Have a separate ILIT buy a $14 million second-to-die policy on Mary and Joe; (3) with adequate collateral (the stock and bond portfolio already owned by Joe and Mary) all the premiums on both policies would always be paid by loans; (4) interest on the loans could be paid by additional loans or paid in cash when due; (5) all loans would be paid when the insureds die.

The magical results: (1) No out-of-pocket premium costs for Joe or Mary and (2) a tax-free death benefit to their children in the amount of $18 million ($4 million, plus $14 million). And a little added bonus: Joe cancelled the old policies and pocketed the $187,000 CSV (tax-free).

CAUTION: Space does not permit every fact, detail and nuance in the above four cases.

What Makes Your Analysis Worthwhile?

Now the question is, what can be done — with the help of our Network insurance consultant — with your policies? Based on our experience, if typical, you can and will increase your insurance coverage and more than double the after-tax proceeds to your family without any additional costs.

First, let’s realize that each life insurance policy you own (or control) on your life or the life of some other person is an asset/investment/piece of merchandise. Like any other asset, you should evaluate it on a regular basis from two viewpoints:

  1. What is the after-tax impact (dead or alive)?
  2. While you are alive, should you keep it, trade it, cancel it, or buy a new one?

Simply put, you are going to make one of three decisions separately for each policy (just as you would do if you were examining a stock portfolio or any other investment):

  1. Keep the policy.
  2. Dump it (pay no more premiums if a term policy; cancel it and pocket the CSV if a permanent life policy).
  3. Trade it in or replace it.

The following analysis is not intended to be scientific or precise, but it sure works in practice — often saving our clients tens or hundreds of thousands in annual premiums and increasing after-tax wealth in millions or tens of millions of dollars.

Keep the Policy

This is usually obvious because you can compare what you have on hand to what is available at your age and insurability. Simply shop to see if you can get a better deal with a new policy. A policy should never be allowed to lapse or be cashed in without a specific reason. So let’s see when you should…

Dump It

This is what you should look for

1. The policy is permanent insurance and is very old. The CSV is about half of the death benefit. You might find this hard to believe, but sometimes the CSV is 80 to 90 percent of the death benefit. And once in a while, the CSV is even greater than the death benefit. What does this mean? The policy is no longer life insurance but has turned into a part insurance/part investment or a pure investment. A lousy investment to be sure. The decision on such a policy is easy. Unless you are uninsurable, dump it.

2. You have term insurance of any kind — whether an old policy or a new one. Many factors are involved here: Are you insurable?…Is the policy convertible?…Would permanent insurance serve your needs better?…A blend of term and permanent insurance? Our experience is that it is an easy decision (to dump the term) when you compare the term premium cost as you get older (start with your present age and get a run to age 95) to the cost of other insurance products available.

Trade It or Replace It

Often trading (tax-free) one or more of your current insurance policies for a new policy is the perfect answer. Always start by getting a quote for a new policy from the insurance company that issued the current policy.

In most cases, if you search the market, you will find that one of the following is your best bet:

  1. Cash in (take the CSV) the old policy.
  2. Use the CSV (all or part of it) as a down payment on a new policy.

Why does trading in or replacing a policy work? Because the insurance industry keeps offering new products that are more cost-effective than the old products. However…

Caution

  • Never cash in an old policy until you are covered by a new policy.
  • If the CSV is greater than the total amount of premiums you paid, the difference is taxable when you cash in the policy. In practice, we have never seen the small tax due change a decision.
  • Your decision should be made only after comparing each policy to what else is available in the marketplace. Don’t guess or estimate. Only compare real offers (must take physical) from real insurance carriers. Ignore estimated proposals. Have your consultant get at least three quotes from top-rated companies. You will be surprised at the wide differences in premium costs.

Let’s Summarize

1. Tax check

Always ask this question: What is the tax cost for this insurance policy — income and estate — when I die? The answer should be ZERO. If not, do what is necessary to make the answer ZERO. This usually means:

  1. Take all existing policies (that you keep) out of your corporation and use one of these two strategies: WEALTH CREATION T or Family Limited Partnership. And we mean it. Whether the policy is owned by you, your spouse, your children (remember, the divorce devil could strike) or some other person or entity. If owned by your corporation, take it out (buy it for its CSV) and transfer it to a WEALTH CREATION.
  2. Any new policies use a SUBTRUST as your first choice, but if you do not qualify (no funds or not enough funds in the right kind of qualified retirement plan), then use the same strategies as for an existing policy (see a. above).

2. Economic check

Always ask this question: Based on what is available in the marketplace today, should I keep this policy? Evaluate each policy separately. Get a current policy run to age 95 or older. Dump and replace as necessary (but only after examining at least two proposals and confirming your selection with a second opinion).

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