BILL BOERSMA: LIFE INSURANCE & ESTATE PLANNING
What to do with existing policies
As might be expected, I’m getting more calls lately from advisors and policy owners asking what should be done about life insurance no longer needed for estate liquidity purposes or due to a change in planning. Sometimes it’s because the kids are out of the house and that house is paid off and retirement has arrived. Other times it is because the policy hasn’t performed very well and they have no interest throwing more money at it.
I generally answer the same way every time: “Let’s evaluate the policy and then talk about options.” Depending on the client situation, the first issue I discuss with the advisor is what happens when the current estate tax law sunsets, and does your client really want to bank on what the tax laws will be, 17, 28 or 42 years from today? With life insurance, it seems many people will jump on a reason to walk away.
The people I deal with are big kids so if they make a decision and regret it later, they can deal with it. However, it’s important that they’re making these decisions with all the data they need to make an informed decision and not an emotional one.
An Objective Financial Analysis
With an in-force ledger in hand, I perform an internal rate of return (IRR) calculation to show them what they have. Sometimes, this is surprising, positively or negatively. What I propose to provide is black and white information. I’m going to stay agnostic relative to product style, carrier and IRR. After all, let’s say the tax-free rate of return at actuarial life expectancy is 5 percent. Who am I to say if that’s good or bad? Someone who has most of his money in CDs and conservative investments might feel that’s a good use of money, while a business owner making 25 percent on her money might question why she’d ever distribute capital to fund such a vehicle.
I take the current cash surrender value and enter it as present value, the death benefit at life expectancy is future value, the number of years to life expectancy (or whatever duration is desired) and the premium payment. I calculate for the growth rate. If the life insurance contract is one that’s designed to accumulate reasonable cash value, I also calculate the IRR on the premium to future cash value so we can evaluate it as an accumulation vehicle.
Let’s take two recent files on my desk. One was a relative new whole life contract. My calculations show the IRR on premium to death benefit at life expectancy to be about 4 percent, while the IRR on cash value is two point something percent most of the time and tops out at 3 percent at age 90. This client decided it wasn’t worth it and is going to exit the policy.
The next policy was a survivor Guaranteed Universal Life on a 77-year-old couple. It was put in force as a single pay and is guaranteed for life with no additional premiums. Running the IRR numbers at 10, 15, 20 and 25 years, the IRR on current cash surrender value to guaranteed death benefit is 16.59 percent,10.78 percent, 7.98 percent and 6.33 percent, respectively. Mind you, that’s 87, 92, 97 and 102 years old. At age 97, they’re looking at an 8 percent guaranteed, net, tax-free return that’s a double digit tax equivalent return. This is an unduplicable financial transaction. Factor that up for an applicable income tax rate and you can see just how attractive that is, especially for a guaranteed deal.
There are some situations where I have discovered the policy would never last even if the client kept paying and other times the policy would be perfectly fine if the client never paid another dollar of premiums. The point is, it’s always worth analysis.
Knowing the return of the transaction, the clients can now decide if there’s any useful reason to keep the contract in the absence of estate taxes or other financial need. If cash flow into a contract isn’t an issue, and it looks to be a good use of money, then the policy can be maintained as a part of a diversified estate portfolio or legacy planning or used for charitable purposes.
Tweaking Existing Contracts
Often I find many people failing to evaluate tweaking an existing contract. If the policy needs premiums, what does the death benefit need to be reduced to for it to stay in force indefinitely with no more cash flow? Is there a way to better use dividends or manage loans? I’ve seen GUL contracts with little or no cash surrender value stay in force for a couple of decades with no premium paid, even when they were designed to assume premiums paid annually.
Assuming a decision is made to bail on the contract, please advise your client to not simply cash it in without further analysis. For some, a life settlement may be a windfall. There’s still a robust settlement market, and this potential increase in value should be evaluated if it’s in the cards. Beyond that, virtually every contract is in a gain or a loss position. If in a gain position, let’s evaluate ways to eliminate or mitigate the gain. If it’s in a loss position, let’s evaluate ways to salvage the loss in the contract. One would never take a loss on real estate or investments and not bother to share this with the accountant. Why should life insurance be any different?
Once everything is evaluated, policy owners can take advantage of the most favorable opportunities or cut and run and put the funds into investments or dissolve the trust and distribute to the kids. The freed-up cash flow can be used for taking the grandkids to Disney or buying that boat you have your eye on.
Long Term Care
When situation change, different financial products are more valuable to consumers. Often nowadays I see boomer age consumers focusing more on future long term care needs than life insurance needs. For those who have diminishing estate tax liabilities and familial financial responsibilities, I see people closely evaluating long term care insurance options and utilizing cash value of no longer needed life insurance to fund it.
In today’s market, hybrid (also referred to as linked benefit or combo) products are more popular than stand alone long term care insurance. The high cost of traditional long term care products, a history in increasing premiums, many carriers getting out of the market and the use it or lose it mentality is causing many consumers to focus on life insurance policies with long term care features. Simplistically stated, the death benefit of these policies is available during life to pay for qualified long term care costs and if someone lives to a ripe old age and drops death of a heart attack, the money wasn’t wasted as a death benefit greater than the premiums would be payable.
There are many flavors to these kinds of policies with some being more of a life insurance policy with long term care features and others focusing more on the long term care benefits. Riders offering long term care benefits greater than the death benefit, and even unlimited beneifts, are available as well as cost of living increases and other bells and whistles.
Especially when a life insurance contract is in a taxable gain position it may be attractive to do a tax-free exchange from the life insurance policy into a long term care style policy. Sometimes the cash value of an unneeded or unwanted or underperforming life insurance policy can be considered found money and makes the purchase of long term care insurance less financially obtrusive.
Life insurance should be evaluated like anything else before making decisions. I’ll always be at a loss to understand why such a significant portion of the market chooses to treat it so differently than anything else.