Imagine this scenario: Bruce is a 70-year-old retired business owner with a 40-year-old son, Rick. Rick has a two-year-old daughter, Ava, and a baby on the way. Bruce wants to help pay for big-ticket items in his grandchildren’s lives, such as college and buying first homes, but he is not particularly keen on plowing money into stocks and bonds. He has already seen what happened to his own stock portfolio during the tech bubble and real estate crisis.
Bruce decides to meet with a Howard Kaye advisor. Here, we show him how life insurance can effectively transfer wealth to his heirs.
Efficient Wealth Transfer
After going through his objectives and running a few different scenarios, Bruce decides to put $25,000 per year into a universal life policy on his life. Given his age and health, his premium buys a $1 million policy.
Buying the policy inside of a properly structured life insurance trust makes the strategy even more efficient because the death benefit will be paid out income and estate-tax-free. Also, Bruce will maintain control over how the money should be distributed by appointing trustees who can see to it that his wishes are carried out.
In Bruce’s case, life insurance is an effective wealth transfer tool and investment alternative for a variety of reasons. In the unlikely event that he passes away before life expectancy, such as at age 80, he will only have paid $250,000 into a policy that will pay out a tax-free $1 million. That after-tax internal rate of return is far superior to any of his other investments.
If Bruce lives into his 90s, he still has the option of taking a loan out against the policy to help pay those tuition bills. He mostly likely would never need to pay that loan back because it can be repaid from the eventual death benefit.
At older ages, Bruce will likely also have the option of selling his $1 million policy on the secondary market for cash. That “life settlement” can provide a significant return over the premiums he has already paid and does not necessitate that he die.
Family Estate Planning with Life Insurance
Let’s look at some other ways life insurance can solve this family’s estate planning issues.
Say Rick is doing well in business and has additional capital to allocate. He may want to consider buying life insurance on Bruce, essentially “creating his own inheritance” by being the beneficiary. If Bruce lives to somewhere between 88 and 90 years old, the payout of the policy proceeds will coincide with a very expensive time in Rick’s life.
At that point, Rick will be in the process of paying college tuition for his kids and making sure that he puts away enough money to fund his own retirement that may only be a few years away. The policy proceeds would provide a tax-free death benefit to immediately cover all of Rick’s major expenses.
Rather than buying a policy on his own life, Bruce may also consider buying a policy on Rick, for the benefit of his grandchildren. Why would he do this? Buying a policy on Rick achieves a similar objective to Rick buying a policy for himself, only it adds in benefits for Bruce as well. He reserves assets from his estate (reducing his future potential estate tax burden) and takes some of the financial burdens off of his son, who may have other financial obligations to think about.
If Rick were to die unexpectedly, his father has now created a nest egg for the family. If Rick lives to life expectancy, his father has pre-funded an inheritance and legacy that can be used by the grandchildren.
In addition,The best part is, if Bruce passes away after paying only a handful of premiums, Rick has the choice of keeping the policy going on his own, reducing the face value, cashing it in, or a variety of other options available to him.
Prioritize Life Insurance
Many of us don’t prioritize funding life insurance and instead scramble to maximize other volatile vehicles such as 401(k)s and IRAs. We often do this because of the abundance of press suggesting the importance of tax-deferred investing.
For the most part, we agree with that, but we also want you to remember that traditional retirement vehicles can become a tax nightmare during the distribution phase. The withdrawals you take from pre-tax investment accounts can push you into a higher tax bracket and reduce the value of your tax deferral.
When you fund life insurance, the proceeds can be 100% tax free with no required distributions. For Rick, buying that policy on Bruce may be the secret ingredient to a comfortable retirement that he never thought about until now.
At Howard Kaye, we have decades of experience creating estate planning strategies rooted in life insurance. Once you learn more about how life insurance can help pass more money along to your heirs, you will embrace our time-tested strategies as well. Contact us today at 800-DIE-RICH to learn more.
