Wealth Planning News
Vol. IV, No. 12
Purposes of Life Insurance
Newsletter 4.11 gave us a more meaningful descriptive phrase for life insurance:
A bunch of money going to
someone when you die.
It discussed Needs Insurance, Liquidity Insurance, Theft Insurance, and Wealth Replacement Insurance. We continue with some other purposes for insurance.
Capital Transfer Insurance
Capital transfer insurance shifts assets from a taxed position to a tax-free position. Example: If you have a large estate subject to federal estate taxes, you can give funds to an irrevocable gifting trust for your children or grandchildren. The trustee will then use the funds to buy insurance on your life. The life insurance passes free of death taxes when you die, because you did not own the policy. Not only do you remove the amounts gifted from your taxed estate, but you also remove tax on the appreciation on the amounts gifted! Because the capital you pay for the insurance is transferred from a place where it was subject to death taxes, into a life insurance policy not subject to death taxes, the process is a capital transfer to avoid death taxes. The insurance you use for the transfer is capital transfer insurance. Don’t think you have to be able to pay for capital transfer insurance out of current income. You can and usually should pay for it with capital taken from other sources. Good advisors can usually find tax-wise ways for you to free up capital that is tied up in other investments. If capital is just sitting in CD’s or bank accounts, even a non-imaginative planner can show you how to make capital transfers into tax free insurance for loved ones. Think of a capital transfer as taking money out of one pocket and transferring it into another pocket or into your wallet.
Wealth replacement insurance is often combined with a charitable trust, and is a capital transfer from a capital asset to tax free insurance, using the CRT as an in between step.
People with large retirement accounts that might be subject to both death taxes and income taxes when they die can also acquire capital transfer life insurance. The methods of obtaining funds to transfer to the capital transfer policy vary in particular cases. Sometimes you transfer other liquid assets you own into the insurance owning entity, using your own retirement funds for normal lifestyle expenses. You do pay Income taxes on such withdrawals, but you may have other deductions to offset the income, or you may just pay some income taxes in order to save more taxes later for your loved ones.
Rent or Buy Capital Transfer Insurance?
Capital transfer insurance by definition has to exist if you live to or beyond normal life expectancy. Therefore you have to buy it instead of merely renting the insurance.
Gift of Love Insurance
You may be the fortunate beneficiary of an ongoing trust that allows you to leave the trust remainder only to descendants of your parent or parents, a so-called “dynastic trust.” That means you cannot leave the trust remainder to your spouse. You may well consider taking some of the income, and even some principal if necessary, to acquire a gift of love policy for your spouse, so that your spouse will have an adequate inheritance if you die first. You write a check to the insurance company each year, perhaps on your anniversary, to pay for the policy. On your check there is a line to indicate what the check is for. You might well write on that line, “A gift of love.”
Imagine parents with two adult sons. One of them is a minister. The other has stayed and worked in the family business. The parents believe the one who stayed should inherit that business he helped to build up, and that forms the bulk of the parents’ estate. But the parents want to make sure they give the minister a roughly equal inheritance. These parents want a bunch of money for their minister son, when they both die at or after life expectancy. To provide it, they buy a gift of love insurance policy.
In other cases there is a need for additional wealth for some of the family members when a large chunk of the estate will pass to one child. Life insurance can provide the cash to the family to equalize the inheritance, or to allow the one wanting certain assets to buy the assets from his brothers and sisters. The parent or parents providing that insurance do so out of love all of the offspring, and to avoid hurting the feelings of any of them. The love for the children is the motive for buying a gift of love insurance policy.
You may need to provide something for stepchildren, either because you love them or because you love their parent who is married to you. If so, once a year, perhaps on your wedding anniversary, you write a check as “A gift of love” for that insurance.
Rent or Buy Gift of Love Insurance?
Since this type of insurance would have to pay even if the insured lives to or beyond normal life expectancy, you have to buy, and not merely rent, this type of insurance.
What began as needs insurance when you had dependents or a need for insurance to cover business debts, could turn into liquidity insurance later, and might well turn into theft insurance, wealth replacement insurance, or just a gift of love. Space does not allow expansion on the issue of investment grade life insurance as part of a diversification of planning techniques, but the variable life policies can definitely be thought of as a diversification of wealth planning techniques while they are meeting some other purposes that may only be temporary.
Rent or Buy Multi-Purpose Insurance?
Because many purposes for life insurance require that it be in place if you live to normal life expectancy, you usually buy multi-purpose life insurance.
Timing of Insurance Purchase
Many planning techniques used by sophisticated planners depend on the insurance being in place before the technique is used or before implementation is completed. Some examples would be charitable remainder trusts, grantor retained income or annuity trusts, and entities for valuation discounts. The best advice we can give clients who may ever need any type of life insurance is this: Buy it sooner rather than later. Buy it now rather than later. Rates are determined by age and present health when you apply for insurance. Your health will probably never be better and your age will never be younger. So make the purchase quickly.
Call us for a consultation if you want more information on this topic.