Monday's Talk: Advanced Life Planning
Excerpts from a talk I gave Monday (okay, okay -- I gave two, but the other one was an informal analysis of
The Godfather), entitled "Why you Need Life Insurance Off the Job: It's More Serious Than You Think."
If you are one of those people who think the life insurance they get on the job is enough, think again. Did you know that the life insurance you get through work is a disturbingly low face amount, typically 1 to 2X your annual salary? Did you also know that in most cases, it is NOT portable. If you were to leave your job or make a career change, your life insurance wouldn't go with you. Finally, those looking to put their money to work should know that the insurance given to you by your employers is TERM insurance, meaning ZERO interest (via dividends if the insurance company you go with is a mutual one) is building on paid premiums. It is not enough to work hard and work harder--you have to work smarter. That means not working for money, but putting your money to work for you.
Let’s take an example--say a police officer (with a wife and one child) has 1 million dollars of coverage given to him through his job. Sounds like a lot, right? Wrong. This plan does nothing for him in terms of saving money for his kid’s college education or supplementing his retirement income. More critically, it serves his family absolutely nothing if he were to die while off duty. A heart attack on a Sunday afternoon in the middle of the Jets game? His family won’t be given a dime. Hence, the biggest problem with insurance granted to you on the job is exactly that -it’s good ONLY if something happens to you on the job. That’s because most insurance granted at the worksite is non-convertible term insurance, which is equivalent to betting you’ll pass before X number of years -- that’s not why life insurance was created. Life insurance, if used smartly, accomplishes three things: limits your liabilities, shelters or freezes your estate, and transfers wealth to the next generation in the most tax-efficient manner. That last point is key -- after wealthy people die, do you know what happens? Their estate is passed to a spouse under what is called an unlimited marital deduction - a nontaxable gift -- in other words (the spouse must be a US citizen). But after the spouse dies, the IRS steps in with an estate tax that can go as high as 48%. Think about it --if you're worth 30 million, get ready to give 15 to the government. Well, you won't -- you'll be dead. But your heirs will pay -- Americans don't work their tails off to give 1/2 of it away upon death last time I checked. With all that said, that is why you take out life insurance and you wrap it in a trust -- you control beyond the grave.
Let me remind you that Life insurance proceeds are federally tax free, that we know. But they ARE not estate tax free. Unless. Unless you remove the insurance from your taxable estate through a trust. Let's take a quick exampleA single person owns one asset: a home worth $750,000. He wants to leave it to his children. He figures that with an estate of $750,000, he needs a policy for $55,000 to pay the death taxes. However, his death taxes are based on his total assets, which usually includes insurance. Because the insurance is subject to death taxes, on his $805,000 estate death taxes are $76,000. His kids come up short.Imposition of death tax on insurance causes a vicious circle; buying more insurance causes an increase in both the taxable estate and the taxes. He needs almost $100,000 of insurance to pay tax on the house and the insurance.
Your main concern should be converting those taxable assets into tax free assets. For those in the financial planning business -- that is the real duty, not to pitch clients this or that, but to make them cognizant of life's realities.
Let's go back to that police officer for a minute. One course of action for this individual would have been to take out a X dollars (lets use a million just for the sake of conversation) worth of PERMANENT insurance and place it in a life insurance trust. On his passing, we would take that death benefit and allocate it to a financial instrument yielding at least a 5% rate of return. Now we have something like an annuity -- 5 % off a million is 50,000 dollars -- do the math. That is precisely the income stream his wife will receive every year while she is alive. The principal or bulk of the policy will go to his child, who can now go to college, buy a car, and live the life his father dreamed for him. Or, on the flip side -- Let's say this client or prospect lives a long and healthy life--great. Now he has the ability to borrow against his whole life policy's cash value in his older age to supplement his retirement income. The cash--which has been accumulating all this time tax free-will also be distributed to him tax free if he's simply taking a loan against his policy. Essentially, the client is creating tax free retirement income to offset the 401K distributions which he will be taxed on. If he hasn’t taken out a ROTH IRA yet, this is even more critical a retirement planning strategy. If he wishes, as his insurance needs abate, he can even rollover that policy's remaining cash value into a fixed annuity or variable annuity by way of a 1035 exchange, which allows you to rollover assets from one financial vehicle to another one without tax repercussions. That annuity will pay him for the rest of his life once it is annuitized. In one swoop, you've done the most you could for this client's family, his most significant beneficiary outside of charity and government (Medicaid is a governmental entity).
It is at this point that you become an asset to your client because you've brought advanced planning to the table -- rather than that regurgitated spiel every “advisor” under the sun is calling him with.
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