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Estate Planning

Life Insurance: The Underestimated Asset in a Wealthy Family’s Portfolio

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By Chris J. Roe, CPA, PFS

Life insurance is typically viewed through a specific lens – as a tool to meet essential needs such as clearing off debts, funding education, or providing for the family in case of an untimely passing. With its lower premiums and customizable term periods, term life insurance is often sufficient to cover these family needs during wealth-building.

But the question arises – what about permanent life insurance for those who already possess wealth and don’t require term insurance to cover premature death? Many consider it unnecessary, aside from estate planning. Given the current estate tax exemption at over $23 million for a married couple, the necessity for life insurance to cover estate tax has diminished considerably. However, our perspective at Rx Wealth differs.

We believe life insurance is a distinctive asset class akin to a bond within a wealthy family’s portfolio. The U.S. Congress has provided generous tax advantages for life insurance. The death benefit is tax-free, the cash buildup grows tax-deferred, and any sale of underlying investments within the policy is tax-free. In certain scenarios, policyholders can even avail themselves of tax-free cash-value loans. Upon the policyholder’s death, these loans are extinguished tax-free.

With these considerable benefits, why is life insurance often disregarded in a wealthy family’s portfolio?

Common objections include perceived high costs, complexity, the time required to fund premiums, and the belief that “we have plenty of wealth, so there’s no need for life insurance.” While some of these concerns are not baseless, they often stem from a needs-based perspective and overlook the potential investment and tax-saving benefits unique to life insurance.

So, let’s make the case for life insurance as a cornerstone of a wealthy family’s assets.

Life insurance is not influenced by traditional investment portfolios or businesses, making it a potential counterbalance to market volatility. By potentially boosting the overall after-tax returns from a wealthy family’s bond investments, life insurance can serve to smooth the fluctuations a family’s wealth may experience over multiple generations.

The primary reason, excluding a specific need, for purchasing life insurance should be based on an anticipated rate of return to life expectancy and should be designed to claim the death benefit at some point in the future. Quick access to the cash value should be a secondary consideration. With a properly structured policy, the family can know the rate of return on their policy investment at any time, providing stability in an unpredictable market.

For example, Rx Wealth recently worked with an affluent family with variable life insurance policies, which came with no guarantees as to the length of the policy’s validity. One such policy was at risk of lapsing when the mother reached age 93 unless significant premiums were paid. Additionally, these uncertain policies were subject to the risk of underperformance, especially as the insured individuals aged and insurance costs escalated.

Understanding these concerns, we helped the family restructure their life insurance portfolio, moving them away from their unpredictable, unguaranteed variable policies and transitioning them to a more stable plan. The new plan offered potential returns of around 4-5% after-tax or 6-7% pre-tax to their life expectancy. This strategic shift provided the family with confidence in their wealth transfer plans and offered them an above-average after-tax rate of return.

Securing Children’s Inheritances with Life Insurance

If your goal is to spend down all assets by your death, life insurance may hinder this plan. However, most wealthy people I meet have the desire to pass some wealth to their children and own some bonds within their family’s investment portfolio. For those who have this intention and are keen on potentially enhancing after-tax returns of their family’s multigenerational wealth, integrating life insurance into the family’s investment assets should be considered.

Life Insurance: A Tax-Smart Investment Strategy

Being in the highest tax brackets, wealthy families often find their investment returns in taxable accounts diminished due to taxes on interest, dividends, and capital gains. The recurring tax burden on realized capital gains also poses a significant challenge to our goal of rebalancing portfolios. However, if properly structured, life insurance can facilitate the long-term deferral or even complete avoidance of tax on investment earnings and realized capital gains. This approach could be a formidable tax planning tool. When properly owned, the death benefit from life insurance is free from income, inheritance, and estate taxes, making it even more appealing.

Life Insurance as an Asset Protection Vehicle

The importance of life insurance as an asset protection instrument is often overlooked. In numerous states and under bankruptcy circumstances, life insurance is treated as an exempt asset. In other words, creditors have a hard time reaching into the cash value. 

Life Insurance as a Tax and Estate Planning Tool

Wealthy families often resort to trusts to transfer assets and future appreciation outside their taxable estate, thereby mitigating estate tax. However, assets held outside a taxable estate forgo the step-up in income tax basis upon death. The decision usually makes sense as you save over 40% in estate tax on the total value of the assets, in contrast to paying over 20% in capital gains tax on the appreciation. In the majority of instances, this is a favorable trade-off.

However, consider the scenario where the trust assets are invested in a life insurance policy on the life of the grantor or both the grantor and their spouse. This strategy enables the assets to enjoy tax-preferred growth during the insured’s lifetime and also acquire a step-up in basis upon the insured’s death, as the death benefit is paid out tax-free. This method can provide a significant tax advantage for wealthy families.

The key to unlocking the full potential of life insurance is to actively manage it as a crucial part of overall wealth, not merely a set-it-and-forget-it item. With frequent reviews and adjustments, life insurance can act as a powerful asset in a wealthy family’s portfolio, keeping pace with changes in the market, health conditions, and innovative product offerings.

At Rx Wealth, we help our clients ensure that their customized strategy consistently meets their needs. We review a client’s insurance portfolio annually because the insurance market constantly evolves with new, innovative products providing enhanced benefits over existing products. Additionally, as clients age, their health changes which may alter our funding strategy to potentially enhance the overall returns realized at death. Our annual review ensures our wealthy families’ customized strategy meets their needs.

If it has been a while since your family has reviewed their life insurance portfolio, please schedule your initial consultation here.

 

Rx Wealth Advisors is a physician-focused financial advisory firm. Their primary focus is to help medical doctors maximize their earnings, keep more money in their pocket, and cultivate wealth so they can live the life they’ve earned and deserve. Rx Wealth can be reached at 412-227-9007, via email at croe@rxwealthadvisors.com, or on the web at rxwealthadvisors.com.

Physicians, Review These 4 Areas of Your Estate Plan in Light of COVID-19

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By: Chris J. Roe, CPA/PFS

Many physicians find themselves on the front line battles of COVID-19 or most certainly has had their practice affected. There are still unknowns related to the pandemic and how it will play out. Over the past few and in the coming months, as this pandemic plays out, I hear many physicians being forced to face fears of falling ill, losing their job, running short on money or spending time in isolation and quarantine away from their families.

It never hurts to be prepared. Thinking about falling ill or not being able to make decisions for yourself can be frightening, but having an estate plan in place can help ease your concerns.

Now may be a good time to review your current estate plan, or if you don’t have one in place, there’s no better time to put one in place.

Estate Plan Documents That Should Be Reviewed & Updated Periodically

Any Individuals over age 18 should have some level of estate planning in place. You may be surprised to learn that wills and trusts aren’t the only documents to prioritize. A strong estate plan includes several important documents, such as a revocable living trust, financial powers of attorney, health care powers of attorney and more.1

In light of the current pandemic, two of the most important documents to have up-to-date and on-hand are a healthcare and financial powers of attorney. For example, if you’re quarantined in your home, admitted to the hospital or become incapacitated, you’ll need someone to handle your financial affairs or make medical decisions on your behalf.

While a healthcare and financial powers of attorney is important, it is always recommended to have comprehensive estate plan that includes the following.

1. Financial and Health Care Power of Attorneys

A financial power of attorney grants authority to carry on a person’s financial affairs and protect their property by acting on your behalf. This includes the ability to write checks, pay bills, make deposits, purchase or sell assets or sign any tax returns.1

Similarly, a health care power of attorney grants the authority to make health care decisions on your behalf should you become incompetent or incapacitated. If you are over age 18 and do not have a health care power of attorney in place, your family members will need to request that the court appoint a guardian to take on these responsibilities.1 Going to court always adds extra stress and costs on a family unnecessarily.

Ensuring that you have named trustworthy, reliable individuals as your powers of attorney is key. If your current documents are outdated, implementing new ones should be on the top of your list.

2. Your Will
A last will and testament is a legal document that allows you to direct distributions of your property at the time of your death. A will also appoints an executor who oversees the distribution of your assets.2 This person will attend to your affairs after you pass, probate your will, if necessary, and file final income and estate tax returns on your behalf. If you have children who are minors, you should also name a guardian to care for them in the will.

Everyone has assets that must transfer after a person’s death, and without a will, there is no direction as to how and to whom those assets will pass. If you pass without a will, you are said to die “Intestate”. When passing intestate, asset distributions are handled by the state according to the state’s intestacy laws and the court decides the best person to oversee estate administration. Also, should you pass without a will and no guardian is named for your minor child(ren), a court will decide on the best person to fulfill this role.2

3. Revocable Trust
In general, a revocable trust benefits you while you are alive and may also be beneficial to others, such as your spouse or children. Identifying who will receive assets upon your death may be a detail that needs updating based on your lifestyle and changes that have taken place. Additionally, you’ll want to outline whether your beneficiaries receive assets outright or perhaps they just have access in trust to income and assets over time. If your beneficiaries are young, consider holding assets for them in a trust until they are older and more responsible to handle finances themselves. In some instances, it is even advisable to keep the money in trust for adult children to provide a level of asset protection against a future creditors or ex-spouses.

Appointing a trustee who manages , when you are not able, your affairs without the involvement of the court, avoids extra time and money associated with probate.3 A trust also affords you privacy regarding the details of your estate since it eliminates the need for probate, which is a public process.

4. Beneficiaries
Another important update to consider in your estate plan is to review beneficiary designations on your life insurance policies, retirement accounts, etc.2 Keep in mind that if you have a joint asset such as a bank account, it pass to the surviving joint owner. Be sure to name someone you trust to act in your best interest should the time come for them to be responsible for your assets.

Due to stay-at-home orders and social distancing practices, it may be more difficult to meet with your attorney or notary in-person to prepare or update your documents. There are template websites that allow you to create estate documents from scratch, and some states have even suspended various statutes to let people appear before a notary public via video conference.4 While some estate documents can be finalized virtually, wills need to be signed in front of witnesses, which means this step to finalizing your documents may need to be done in person.

While we always recommend you seek professional legal counsel to implement your estate plan, doing it yourself may be better than not having a plan at all. During this times, you should start reviewing your estate plan and making any adjustments with the appropriate professionals as needed. Making necessary, important changes now will likely benefit you and your family in the future.

1https://www.americanbar.org/groups/real_property_trust_estate/resources/estate_planning/
2https://www.americanbar.org/groups/real_property_trust_estate/resources/estate_planning/an_introduction_to_wills/
3https://www.consumerreports.org/cro/2013/11/how-to-create-a-bulletproof-estate-plan/index.htm
4https://www.americanbar.org/groups/law_aging/resources/coronavirus-update-and-the-elder-law-community/notarization-in-the-age-of-covid-19–the-status-of-states/

Disclaimer:

2020 All Rights Reserved. This content is developed from sources believed to be providing accurate information, and provided by Twenty over Ten and Rx Wealth Advisors, LLC for general informational purposes only. It may not be used for the purpose of avoiding any federal tax penalties and in no way is meant to provide specific tax, legal or financial advice. Please consult legal, financial or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any financial advice or investment security.