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Life insurance often gets a bad rap. But when you approach it as a financial and estate planning tool, a whole new array of opportunities unfold.

Wealth transfer

Life Insurance or Family Trust? The Benefits of Both May Be Worth Exploring

  • Jim Mari
  • 12/12/2018

It’s an unfortunate fact that many people — clients and financial advisors alike — run for the hills when the words “life insurance” enter a conversation. Let’s face it: No one wants to talk about his or her demise. The stereotyped image of the beady-eyed insurance salesman in a plaid suit (think Ned Ryerson in the movie Groundhog Day) doesn’t paint a positive picture, either.

However, if you can move past all of that, you can see that life insurance can be a versatile financial planning tool and asset class. Most people don’t realize that potential tax-advantaged returns, stock market resilience, and other benefits mean it can also be used for inheritance and legacy planning.

To illustrate the point, let’s take a look at two examples, one showing life insurance as an asset class in legacy planning, and the other as a model for estate equalization, and to a lesser extent, business succession planning.

Transferring wealth with insurance instead of a trust

Let’s say that a person wants to leave money to his or her children, other heirs, or a favorite charity. Lots of people will set up a trust and fund it with real dollars or investments. This is a fine idea. However, this strategy is subject to the costs of managing the trust, possible stock market and/or interest rate fluctuations, and tax considerations.

Using life insurance as an asset to heirs offers some advantages over trusts. Consider this example with the following assumptions:

  • Insured is a 70-year-old female widow and her health rating is standard non-tobacco.
  • She doesn’t need the required minimum distributions (RMD) from her IRA, and wants to use them instead to fund a legacy plan. Her IRA balance is around $700,000, so her first RMD will be about $27,000. We will say she will net $22,500 (after taxes) and we’ll use that amount as the annual premium to fund a guaranteed universal life policy.

Results:

  • $22,500 of annual premium will buy a death benefit of approximately $774,743. That death benefit is tax free and bypasses probate since the policy holder can designate beneficiaries.
  • If she dies at an average life expectancy at age 87, the tax-free internal rate of return on the death benefit is 7.43 percent.

In the current economic environment, a 7.43 percent annual, tax-free return is certainly worth considering. And with the insurance, there are no annual investment advisor management fees, or worry about stock market returns.

Insurance for estate equalization and business succession planning

Our second example is a business owner who has three children and is widowed. Two children are in the business, one is not and has no plans to be. The business is valued at $1.5 million and the owner would like to leave the same amount of assets to each of his three children.

Let’s use simple math and assume there are no assets other than the business to leave as an inheritance. Under that assumption, the two children working in the business will receive $750,000 each ($1.5 million divided by two) and the other child will receive nothing.

The typical inheritance model may leave the family in a sticky situation:

1

Split the business interest three ways. But is this fair? The two children running the business can share revenue with the third one, but this may lead to family resentment since two are working for an income from the business and the other is not.

2

The two active children could buy out the third for fair market value, but that raises another set of variables that could put a strain on all three heirs:

  • Do the siblings have enough cash for a buyout?
  • How long will the payout period be if a lump sum is not feasible?
  • Will interest have to be paid until the buyout is complete?

Life insurance might be a simpler option for this family. The business owner (or his children) could purchase life insurance on the owner of the business in the amount of $750,000, with the sibling who is not involved in the business as beneficiary. When the owner dies, the business goes to the two children and $750,000 in cash from the life insurance policy will go to the inactive child.

This strategy is much cleaner. The two active children don’t have to be concerned with involving the inactive child in decision-making in the business and they don’t have to share future profits or appreciation. The inactive child gets an infusion of tax-free cash in the amount of $750,000. Family harmony is maintained and the father’s wishes are achieved.

How we can help

Life insurance can be a versatile financial planning tool with advantages over traditional strategies for inheritance and business succession planning. CLA’s experienced team of insurance professionals can guide you in making decisions about life, disability, and long-term care insurance, and annuity products. Our advisors are not paid on commission and are not tied to any insurance carrier, so you can expect personal attention and objective, non-proprietary advice and recommendations.

  • Jim Mari
  • Senior Wealth Advisor
  • CLA Philadelphia Plymouth Meeting
  • CliftonLarsonAllen Wealth Advisors, LLC