Posts filed under 'estate taxes'
Writing a check for your life insurance premium may not be up there with getting a hot stick poked in your eye, but it certainly isn’t as soothing as writing a check for a Carribean vacation either.
So, if I asked you this. Do you like writing checks to the IRS? If you could avoid writing a check to the IRS by writing a smaller check to a life insurance company, would it make that premium payment at least slightly more pallatable?
I’ve had clients on complete opposite sides of the mountain when it comes to the issue of estate taxes. Some are right with the program. Show them an affordable way to keep their estate intact for their heirs and they are on board. Others have point blank told me that they don’t really care because they’ll be dead.
Let me just turn on the lamp over this mess on the table. If you have a substantial estate and have not put anything in place to protect it, when you die, your heirs will have 9 months to make sense of it all, determine the value, and liquidate enough of the estate to pay the estate taxes. It is precisely this scenario that plays out with easily half of taxable estates.
The result is that often as much as half of what you worked your entire life for will not be passed on to your family, many of the assets you have accrued will be sold off for pennies on the dollar due to the time limit, and your heirs are probably going to wonder how, if you were smart enough to create all of that wealth, why weren’t you smart enough to protect it.
Bottom line. Estate taxes are a fact of life. Even if the US government repeals estate taxes, states stand ready to increase state death taxes to continue the taxation from another direction. Life insurance owned by a life insurance trust can pay those taxes for pennies on the dollar. Who would you rather write a check to?
October 14th, 2007
Most life insurance trusts are funded by permanent insurance, either universal life or whole life. This is generally not an inexpensive proposition, but compared to estate taxes, by far the smaller hit.
I mentioned in a previous post that the ownership of a policy for estate purposes really needs to be a trust. I also mentioned that there are policies that will double the amount of coverage for a long enough period to ensure that a trust is set up and that the IRS three year rule is put to rest.
Another way to accomplish the same thing would be to take an even less expensive route of securing your estate with term life insurance on you and your spouse. This does what I have always preached loudly, it puts the insurance in force. Something is always better than nothing.
Worry about the details later. Do you really think your heirs will care if you bought term insurance or universal life if you die six months from now. Considering the cost of a permanent second to die policy, you and your spouse will likely pay a lot less to carry double the amount of term insurance.
Once the trust is set up, apply for the permanent coverage through the trust, and replace the term policies once everything is approved. The IRS doesn’t have any problem with that plan of action.
Bottom line. Whether it is through an independent life insurance agent, an estate planner or estate tax attorney, learn the proper way to use life insurance to protect your estate. Once you understand how it should eventually be set up, don’t waste any time waiting for the attorney to set up a trust. Put adequate life insurance in force and make any changes you need down the road.
October 7th, 2007
As explained in a previous post, if the owner of a policy sets up a life insurance trust and changes the ownership and beneficiary to the trust, and a death occurs within three years of that change, the IRS will roll the clock back to original ownership and beneficiary. This could potentially put millions in estate value into a taxable situation.
So what if you are stuck? On the one hand you have an estate planner telling you need life insurance for estate tax protection. On the other hand you have an estate tax attorney working at a snail’s pace to put together an irrevocable life insurance trust, warning you not to buy life insurance until the trust is in place.
Well guys, let’s be real about the attorney. He is suggesting that you just chill until he gets around to your trust. If you happen to die next month, do you think he is going to step in and provide your heirs the millions they would have received if there was life insurance in force? I’m not thinking that’s not happening.
Several companies have provided a vehicle for this very issue. It is an estate protection policy that, for the first four years, has double the death benefit. This allows time for even the slowest attorney to set up a trust, a change of ownership to the trust to be accomplished, and the three year look back period to expire. During that period the policy has built in the additional insurance to cover the larger estate value due to improper ownership of the policy.
So, in real numbers, let’s assume you have a $5mm estate. There is a $2.5 exemption which leaves $2.5mm taxable at about 50%. Estate taxes due, about $1.25mm, so the person takes out a $1.25mm policy with himself as owner. Unfortunately, because of the ownership, the life insurance gets added to the total estate rather than being there to pay the taxes.
So, reality is that he has a $2.5mm taxable estate and his life insurance adds $1.25mm leaving a taxable estate of $3.75mm. Taxes due are about $1.8mm. He has left $1.25mm in life insurance to deal with that bill. That means the heirs are liquidating about $600k of the estate to pay the remaining taxes. Not a desirable outcome.
Scenario number two doubles the death benefit. He has $2.5mm taxable. He takes out a policy for $1.25mm with a double face amount for the first 4 years. Upon his death, the $2.5mm (double face amount) is added to his estate, making the taxable estate $5mm. Taxes due $2.5mm, but remember, he has $2.5mm in life insurance to pay the taxes. Let’s call that break even which is exactly the outcome you want.
Bottom line. If estate tax life insurance is needed, it is needed now, not when your attorney gets around to creating your trust. There is more than one way to shine that pair of boots. Check with an independent agent who will have access to the companies that have this benefit.
October 7th, 2007
Life insurance proceeds are about the only source of money that is income tax free. This gives added value to the benefit that you leave your beneficiaries.
There is one area that you need to be careful with beneficiary designations. The IRS has a three year look back rule whenever there has been a change of beneficiary, not for income tax, but for taxable estate value. What they are trying to prevent is someone changing beneficiaries when they know they don’t have long to live, to avoid estate taxes.
Life insurance, if owned by an individual, while not income taxable, is added to the value of the estate upon death. With proper estate planning, an irrevocable life insurance trust would be in place at the time the life insurance is purchased. The trust would own and be the beneficiary of the life insurance. Since the individual doesn’t own the policy, the IRS says it is not added to the value of the estate.
The problem comes when an individual owns a policy, his or her estate grows to the point of being taxable, and they decide to change ownership of the policy to remove it from the estate value. This triggers the 3 year look back. If the individual dies within 3 years of this change of ownership, the IRS will deem the original ownership takes precedence leaving it in the estate and added to the taxable estate value.
I have had clients on several occasions discover that they aren’t following their estate attorney’s orders after the policy is already applied for. Changing the beneficiary after the insurance is applied for falls within the same 3 year rule. When investigating ownership for estate tax purposes they will actually look back to the original application to see what changes were made by application amendment. The original intent stands.
Life insurance is set up incorrectly every day, usually due to the ignorance of the agent. We’ll look at a couple of viable options to deal with a poorly thought out purchase in a subsequent post.
Bottom line. Care needs to be taken. Advice from estate planners and estate tax attorneys should be sought. Whenever you are buying substantial amounts of life insurance, quiz your life insurance agent on estate tax consequences and how to structure ownership.
October 7th, 2007
Term insurance or whole life? Term insurance or universal life? How should you decide just what product best fits your need for protection for your family?
I’ve discussed in numerous posts how to determine the proper term length and the proper use of term insurance. There are plenty of good reasons for permanent insurance. I have beat to death the subject of whole life versus universal life so for the purposes of exploring the uses we will stick today with the generic permanent.
The key element in determining term versus permanent is the length of the need. In the case of permanent insurance, it’s a matter of a need that just doesn’t go away.
That need can take several forms, but let’s start small and work our way through life insurance policies that, by the nature of the need, you simply do not want to outlive. Probably the purest example would be a burial policy, also often called a final expenses policy.
In either of these instances, outliving the policy you’ve been paying for simply doesn’t make sense. It is a permanent need. You need it to be there when you die.
I will use an example from my own portfolio as another need that is clearly permanent. I carry enough term insurance of varying lengths to ensure, at any given point through age 80 or so, there will be enough insurance to take care of my wife’s needs it my absence. I also have a $50,000 permanent policy.
The reason I carry this policy and the reason I believe it should be considered in most situations with husbands and wives, is that I believe it is a smart move to provide your spouse with enough money to bridge the gap between your death and their activation of the plan for the rest of their lives. In my case I believe there will be plenty of assets. What I don’t want my bride to have to do is make any kind of rash decision on how to use them.
Many people carry life insurance policies purely for the purpose of leaving money behind to their adult children. If that is a desire of yours, you should absolutely consider permanent over term. What you don’t want to do is put substantial money into a term life insurance policy for your children, and then outlive the term. At that point you would have to make a choice of dropping the plan, applying for more term insurance at higher prices (with the chance of outliving it again), or converting it to a permanent policy at a higher rate than you would have had to pay 10 or 20 years earlier.
There are plenty more, but the last example I will throw out is that of estate protection. Whether it is federal estate taxes or state death taxes, someone is going to want a bite out of any substantial estates. Carrying life insurance for the purpose of paying these taxes is a prudent move, but definitely a another example of a policy that you simply don’t want to outlive. Anything short of permanent could potentially cost your estate rather than saving it.
Bottom line. Term insurance fits by far the majority of needs, but there are plenty of good, solid reasons for permanent insurance.
September 16th, 2007
Is the need for second to die life insurance going to go away? Will the estate tax really disappear in 2010? Should you jump to decrease your life insurance because of the new exemption limits?
Well, in the world according to me the answers would be NO, NO and NO! The $3.5 million exemption that will go into effect in 2009 is, I believe, where congress will vote to keep it in 2010. They will have accomplished what the real objective was and that was to end the devastation of smaller estates, the areas that hit small business owners and agricultural families the hardest.
The Center on Budget and Policy Priorities released a “State of the Estate Tax” article recently that reviews in detail what has been accomplished. There isn’t any doubt left when you read the article that the increase in exemption limits was the right thing to do. Abolishing the tax altogether would, in my opinion, not be.
I believe that the life insurance survivorship policy, the long time estate preservation tool, will continue to be the choice in the future. Even if the federal government abolishes the tax (again, very doubtful), the missing funds will be made up by an increase in state death taxes. If you don’t believe that, look at how Washington state has poised themselves to fill the void. They’ve incrementally increased their death tax as the federal exemption has become more lenient.
Bottom line. As long as there are estate taxes, life insurance will be the most practical means of dealing with them.
August 23rd, 2007
Here’s where you can get a whole helping of my opinion that has grown and matured and reformed and settled since I sold my first whole life life policies in 1978.
Both whole life and universal life are meant to be permanent insurance. They are meant to be there until you die because they are covering a need that never goes away. A very simple example of a need that never goes away is burial insurance. It is almost always a whole life policy and should absolutely be guaranteed to be there when it is needed.
A larger example of the need for permanent insurance is an estate preservation policy, a policy designed to provide the money to pay estate taxes. That need is there until the death of the owner of the estate. In the case of a married couple the ownership passes to the surviving spouse when the first one dies. When the surviving spouse dies, taxes come due. This is generally covered by either a whole life or universal life second to die policy. In the absence of insurance, most of what a couple earned and worked for could go to the government and not their heirs.
Generally speaking I think universal life is the better product. It is more affordable and can be guaranteed to stay in force longer than anyone has ever lived. The thing I really like about it and the reason it is more affordable, is that it can be structured to accomplish it’s mission without massive amounts of cash value buildup.
Life insurance building cash value really catches a lot of attention. The instant image for most people is having your cake and eating it too. With very few exceptions, the cost of building that cash value is much too high. In a later blog I will provide some actual scenarios to back up my opinion.
I beleive everyone should have some amount of permanent insurance. Call it final expense money. Call it burial insurance. I carry $50,000 of permanent insurance so that, when all the term insurance is gone and we are living on our retirement, if I don’t wake up some morning my wife won’t need to borrow money or liquidate assets until she has had time to put together a plan. I call it bridge money. It builds a safe bridge from my passing to her plan.
I will cover this more later, but when you are looking at permanent insurance, always, always make the agent show you the guarantees in the policy. If it isn’t guaranteed past age 100, send the agent back to the drawing board or find another agent. The last thing you want is a permanent policy that wasn’t guaranteed and believe me, there are plenty of them out there. Millions of policies currently in force are not guaranteed to do what the agent said they would. Make them show you the guarantees.
July 18th, 2007
A Simon and Garfunkel song with the line, “my lack of education hasn’t hurt me none”. Well that may be just fine for most life insurance agents, but the fact that it hasn’t “hurt them none” isn’t really the point. How many clients are financially damaged every day by life insurance agents who refuse to learn about their own business?
You should see the test it takes to become a life insurance agent. It’s not even meant to weed out those that who were to lazy to study. Even the continuing education courses are for the most part a joke.
So it’s just sales right? What do you need to know other than “what will it take to get you to drive away in this life insurance policy today”? Well, allow me to express my opinion on this based on far more years in the business than the average agent will ever last.
If I were teaching the school, closing the sale would be left out. Knowledge of impairments, knowledge of insurance and estate law, and good customer service would be the curriculum.
How can an agent hope to do the best possible job for someone with heart disease or a history of cancer if you don’t know what the results of a stress test or a pathology report mean? How can an agent advise a client who is treated for depression if they don’t know the difference between situational or chronic depression? How can an agent hope to help someone who has been through drug or alcohol treatment if they don’t know how underwriters from different companies view the issue? How can an agent help a private pilot find the best life insurance pilot if they don’t know the difference between IFR and VFR? The answer to all of these is the agent can’t properly help those clients because they haven’t bothered to educate themselves.
How can an agent give proper advice about the use of life insurance in estate preservation if they don’t understand estate tax law? How can an agent advise a client on the need for a life insurance trust if they don’t understand the tax law that applies? How can an agent even represent the products unless they know the regulatory implications of their advice? Again, they can’t!!
A poorly educated life insurance agent is bad for the client and bad for the business. I honestly believe that states shouldn’t take the licensing of agents so lightly. A person should have to prove knowledge way beyond what is currently required before they are ever allowed to give advice to someone about matters that will impact that person’s family in critical ways.
And you ask why does this bother me so much? Because it allows someone with a gift for selling to give bad advice and damage clients and get paid for it. Just my opinion of course.
June 7th, 2007
Let’s start with definitions of whole life, term insurance and universal life. Whole Life as a product it is very rare anymore. These days it is actually more of a generic term referring to permanent, usually universal life insurance.
The definitions! Whole life insurance, if sold correctly, would offer a level premium to age 100 with a cash value accumulation that, at age 100, would equal the death benefit.
Term insurance offers a guaranteed level premium and death benefit for a specific number of years. 10, 15 , 20 and 30 year terms are the most frequently used product.
Universal life, if sold correctly, will have a no lapse guarantee and offer you a guaranteed level premium to age 100. At that time, if you’re still around, no more premiums (payments) are due, and the policy would stay in force until your death.
When I say whole life is something of a generic term these days, what has happened is that newer and better products have entered the marketplace. In most cases they offer better guarantees and better prices than a true whole life policy. So the real question is should you have term insurance or universal life insurance with a no lapse guarantee.
Two quick questions take 90% of the guesswork out of the decision.
Term question! Can you foresee a point in the future of 30 years or less when you will not need the amount of insurance you need now? A few examples….if you have a 10 year loan and want life insurance to pay it off if something happens, a 10 year term is the right product. If you have a young child you would want a long enough term to get them to the point that they are no longer financially dependent on you. For most a 20 year term would suffice, but if you were planning on having more children it might be prudent to lock in a 30 year term.
Universal life question! Is the need permanent? Examples would be a final expense policy. Final expenses don’t occur until you die, so permanent is more appropriate than term. Estate preservation is another good example. If your estate is large enough that you need to carry life insurance to help defray the estate taxes upon your death, you don’t want a policy that you can outlive.
Lastly, if someone suggests you buy a whole life policy, I suggest this course of action. Tell them you want them to provide illustrations of the whole life policy along with illustrations of a universal life policy with a no lapse guarantee. Then ask them to show you a commission schedule that shows what they would earn over the next 10 years on each of those options. If they actually provide the information I think you will have an eye opening education into why some people still sell whole life.
February 3rd, 2007
As we close in on 2010, the year that congress is slated to do away with estate taxes, is there anyone out there that really believes estates won’t be taxed after 2010?
Personally I believe the government will take action to leave the estate tax on the books. The good news is that the spousal exemption limits that were just over $600,000 in the year 2000 will likely be much higher, probably being capped somewhere between the current $2,000,000 and the 2009 proposed level of $3,500,000.
Let’s just pretend for a minute that the Federal government decides to follow through and repeal the estate tax in 2010. That would free everyone up to dump the life insurance policies that they have in place to pay estate taxes, right? WRONG!!
States are already seizing the day with the slack in the new exemption limits. Washington state has reared the ugliest head so far by instituting up to a 19% “death tax” on estates for Washington residents. If the repeal really did go through you can bet that the states, seeing an opportunity for new revenue, will fill the void before the ink on the repeal dries.
January 31st, 2007
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