3Topics What’s the “estate plan”? Planning after the American Taxpayer Relief Act of (ATRA) and the 3.8% net investment income tax (NIIT)Effect on traditional life insurance needs analysisUse of life insurance as an investmentLife insurance for estate liquidityLife insurance as a form of capital transferPro-active planning with irrevocable life insurance trusts
4What’s the “estate plan”? Depends on whom you ask, but for me, it’s an artful blend of documents, arrangements, assets and income streams that create and fund a structure that will:Prepare the individual for living dependentlyProvide for and protect the individual’s surviving spouse, children and any others whom he or she wishes to provide for and protectPrevent family disharmony (or cause it, if that’s the objective)Reduce survivors’ stressAnd, finally, preserve the estate from taxes and expensesNow we can talk about life insurance in the estate plan
5Planning after ATRA and the NIIT ATRA and the NIIT have created strong headwinds against accumulating an estate. On the other hand, ATRA provides higher, indexed estate and gift tax exemptions. The combination of these income and transfer tax forces can have some interesting implications for the role of life insurance in an individual’s estate plan.Individuals who are using (or considering) life insurance for pure protection might need less coverage for less time or more coverage for longer–it depends!Individuals who are supporting (or considering) life insurance for estate tax liquidity might find that they either get by with less insurance or a less permanent form of insurance or will have to maintain or increase their current insurance program
6Some “basic” questions for the individual How much life insurance do you have?How was that amount of coverage determined?What were the key objectives and assumptions you used to determine the amount of coverage for each need?Do you still have those objectives? Are those assumptions still valid?Do you know if you own the right type of products?Do you know if your coverage is competitively priced?Are you sure the policy ownership and beneficiary arrangements are appropriate and tax-efficient for your situation and objectives?
7Insurance needs analysis after ATRA, etc. A life insurance needs analysis is one of the fundamental components of a personal financial plan.Compares the needs that a surviving spouse and/or other dependents will have for capital with its sources, all based on assumptions that include projected tax rates on the survivor’s income.Pre-2013 analysis should be re-run to reflect the combined effect of ATRA and the NIIT on the “inflection point” for the sufficiency of an individual’s assets to provide for the survivor and on the projected after-tax return on the survivor’s income.The point is that the analysis should consider both!
8A closer look inside a needs analysis Immediate needs or set asidesExpenses, debts, income taxes, etc.Estate taxesIf so, when, how much and, if at the “second” death, will they care?Mortgage(s)Pay off or just keep paying?What’s the clinical test? Now what’s the visceral test?Education funds for childrenFunds for resumption of education for surviving spouse?
9A closer look inside a needs analysis Income needsHow much money will the surviving spouse need (or want) on an annual basis?Note changing needs as spouse and children get olderDoes he or she want to live off of income only or consume principal as well?Does he or she understand the costs/risks inherent in this choice?By the way, how long will the survivor live?
10Capital sources (and associated questions) Social Security and other survivor benefitsStarting when, how much, adjusted for inflation, etc.?Existing life insuranceHow much is payable in all events vs. only if death occurred at work?InvestmentsWhat’s an appropriate assumption for the after-tax return for the survivor’s portfolio?If continuing tax deferral of qualified accounts is desirable, will the survivor be able to afford to keep the money in the plan?Spouse’s wagesWill the surviving spouse be able to maintain those earnings?Will the surviving spouse (really) return to work outside the home?
11We know the right amount…now what? Rule of thumbTerm insurance is appropriate for needs that will last no more than 20 years (with gusts up to 30)Needs of greater duration should be funded with cash value insuranceOK, but what kind, and under what assumptions, and for how long?Ask, what will change after 15–20 years?The amount of the needs?The composition of those needs?Now put down the rose-colored glassesHmmm…maybe the agent was right all along
12Insurance products as tax-advantaged investments Deferred annuities offer tax-deferred inside build-up, but:Withdrawals and loans are ordinary income to extent of gain in the policy.If the owner is not 59½, there is a 10% penalty tax, with exceptions.Income from annuities is subject to the NIIT.Beneficiary must pay tax on gain, i.e., no stepped-up basis,Life insurance also offers tax-deferred inside build-up, tax-free death benefit, plus other advantages.Withdrawals to basis and/or loans are tax-free and not subject to the NIIT if policy is not a modified endowment contract (MEC).Be aware of impact of excessive loans on policy viability and the tax implications of a lapse due to those loansObservations on selection and design of the investment-oriented policy
13Life insurance for estate liquidity Help the individual map out his or her estate liquidity needs (including the needs for capital for non-tax purposes) at each spouse’s death.Incorporate the permanent exemption and index it at an assumed inflation rate to the death of the individual.Incorporate assumptions for after-tax growth in asset values, consumption and the benefits of whatever additional estate tax reduction planning the individual will do.What hath the software wrought?Is the estate so large and the liquidity need so great that the individual will still need every bit of coverage he or she has (and then some)?Or, will the liquidity cost curve fade away over time, perhaps because of the indexed exemption or just because there is more projected consumption than appreciation?
14Treasure, toss or tweak that policy? If the liquidity need isn’t beyond question, an individual who already has insurance should determine whether the current insurance program cost-efficiently tracks the new curve or is a blunt 55% of the original need, maybe even increased by inflation.The individual considering a purchase (or considering revamping existing coverage) might find that:Rather than a heavily funded permanent policy, a 15 to 20 year level premium term policy may provide all the liquidity he or she needs for the time it’s needed. But be aware of and plan for conversion risk!If the liquidity need will persist, then still consider “layering” some term insurance with some permanent product if that can adequately track the liquidity cost curve.
15Life insurance as a form of capital transfer Many high net worth individuals use life insurance as a trust investment for pure wealth transfer.They believe that the “IRR” on the death benefit may be as good or better on a risk and attitude-adjusted basis as anything else they would use for this purpose.This may be a worthwhile use of the $5.34 million exemption.Policy selection and design implicationsIndividual or second-to-die?Importance of premium flexibility, cash value accumulation and other policy characteristics
16A good time to come to the aid of your ILIT? Many irrevocable life insurance trust (ILIT)-owned policies are living lives of quiet desperation and need much higher premiums to support their death benefits.The additional funding might have triggered gift tax or perhaps created unfavorable generation-skipping transfer (GST) tax implications.Many policies owned by ILITs are subject to split-dollar arrangements need more cash to roll out from the plan.Again, the additional funding might have triggered gift tax or perhaps created unfavorable GST tax implications.In either case, there is now more latitude to fund those trusts without gift or GST tax cost or to absorb the gift tax cost of unwinding the split-dollar plan.
17A good time to come to the aid of your ILIT? An individual who is reluctant to use gift tax exemption but wants to shore up existing ILIT policies or planning can consider:Creating a GRAT funded with income-producing property that will distribute its remainder to the ILIT, thereby enabling the ILIT to contribute to the premiums.If the ILIT is a grantor trust for income tax purposes, selling an income-producing asset to the ILIT in exchange for an installment note at today’s very low applicable rate. The ILIT can use any residual net of the note repayment to pay premiums.Lending to the grantor trust ILIT at the applicable rate. If the ILIT can earn enough on the loan proceeds to service the loan and retain a healthy sum, that sum can generate cash to contribute to premiums.
18What advisors should ask agents How do you determine the kind of product that is suitable for the individual?Describe “real life” situations where you recommended different types of products to meet different types of needs.Describe situations where you designed the same type of product differently to meet differing needs/circumstances.How do you compare and evaluate similar types of products?Describe situations where, for reasons other than underwriting, you recommended different carriers for different individual needs.Describe your ongoing (post-purchase) services.
19What agents should ask advisors What roles do you see life insurance playing in an estate plan?How do you integrate life insurance in the estate plan?How do you like to work with an agent? What do you like to see from an agent to be comfortable that the agent is adequately serving the individual’s needs?What kind of support do you look for from agents on advanced cases?