Advanced Underwriting Consultants

Question of the Day – October 26

Ask the Experts!

Here’s the question of the day.

Question: My client wants to wait to draft his irrevocable trust until after he’s sure he wants to buy the life insurance.  How can I make that work?

Answer: Life insurance death proceeds are includible in the taxable estate of the insured if the insured owns the policy.  If the insured transfers a policy on his life by gift, and dies within three years of the transfer, the death benefit is also included in the insured’s taxable estate.

To avoid having life insurance be included in the insured’s taxable estate, we usually recommend having an irrevocable life insurance trust (ILIT) own the policy from inception.

In a perfect world, ILITs are implemented this way:

  1. The ILIT is created and funded by the grantor.
  2. The trustee of the ILIT sends withdrawal notices to the beneficiaries.
  3. The beneficiaries decide not to withdraw the money.
  4. The trustee decides to apply for insurance on the life of the grantor.
  5. The insurance is approved.
  6. The trustee pays the premium.

The reason for these theoretical steps is to conform to the requirements of the court cases and ILIT rules and regulations.

The procedure described is NOT the only way to achieve estate tax exclusion of the death benefit.  However, some variations from the perfect implementation may create a danger of inclusion in the grantor’s estate for three years after the purchase of the insurance.

According to IRS Technical Advice Memorandum (TAM) 9323002, an application can be submitted to the insurance company without any kind of premium deposit, and so long as the trust is executed by the completion of the underwriting, a new application can be filed with the insurance company.  If the policy is issued with the trust as the owner—and the first actual premium payment is made by the trustee as the owner—then the IRS said there’s no policy transfer.  No transfer means no three year estate tax inclusion.

A prospective insured following the TAM procedure might sign an application, get approved for the coverage, get his lawyer to draft an ILIT in a hurry, and have the agent ask the insurance company to list the trust as owner and beneficiary prior to the policy being put in force.

Of course, the TAM is not authority that any particular taxpayer can rely on, but it is a reflection of how the IRS generally looks at these issues.  The best advice is to let the client’s attorney make the call on whether the attorney is comfortable with the procedure described.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – September 22

Ask the Experts!

Here’s the question of the day.

Question: Why would a business owner consider key employee life insurance?

Answer: Key employee life insurance can meet a number of business needs.

A key employee is anyone who affects the overall success and profitability of the business.  A key employee could be a manager whose judgment and leadership are crucial to the business; a sales representative with knowledge of the product and customers; or any other worker who has unique technical experience or good rapport with customers, creditors, or fellow workers.

The death of a key employee may cause the loss of management skill and experience.  This could be particularly traumatic for small companies with only a few managers.  The death of a key sales representative could cause the loss of customers loyal to that particular individual, and will affect sales in general.  The death of a key employee could hurt the company’s credit rating and the ability to obtain credit in the future.

The death of a key employee will cost the business the expense of hiring and training a replacement.  The business owner may feel morally obligated to provide a substantial death benefit to the key employee’s family.

The premiums on a key employee life insurance policy are usually small compared to the death benefit. If a permanent policy is used, the cash values are shown as a business asset on the company books.  This may increase the company’s credit rating and can be a source of money in a financial crisis.

If the key employee is also an owner, a key employee policy death benefit can be used to fund a buy-out of the deceased owner-employee’s interest in the business.

Determining the amount of key employee insurance is not a precise process; it will depend upon the facts and circumstances of each situation.  Here are some broad guidelines.

In the case of sales representatives, product designers and research persons whose loss might directly cause a measurable loss of sales or earnings, advisors recommend using a multiple of lost sales or earnings.  For example, suppose a business owner estimates that the loss of a key sales rep would cause a drop in sales of $100,000 per year for five years, while a new sales rep learned the product and territory.  A key person policy of $500,000 would be in order.

Where key managers or financial officers are involved, the direct impact on sales and earnings may be harder to measure.  Many advisors recommend using a multiple of salary in those cases.  For instance, if a key manager is making $100,000 a year and the owner estimates it will take three years to recruit, train, and bring a new manager up-to-speed, a $300,000 policy would be advisable.

With key person coverage, the business applies for and is the owner and beneficiary of a policy insuring the key employee’s life.  The business pays the premiums.  The premiums are non-deductible when paid, but the death proceeds are generally tax-free to the business.

In some cases, businesses with over $5 million per year of revenue may be subject to alternative minimum tax on death proceeds.  Also, Section 101(j) of the IRC requires special notice and waiver rules to be followed to preserve the tax free death benefit.

A key employee life insurance policy has no tax effect on the insured employee.

If a cash value policy is surrendered by the employer, the proceeds are tax-free to the extent of premiums paid; any gain will be taxed as ordinary income.  Policy loans are available to the employer and are usually tax-free as long as the policy stays in force.  Loan interest may be deductible by the loan business on a limited basis.

While key employee insurance seems like a simple idea, it can help a business owner client protect his investment.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – September 14

Ask the Experts!

Here’s the question of the day, answered by guest blogger Paul McGillivray.  Paul is Senior Vice President of Advanced Marketing at Creative Marketing.

Question: What are the most exciting product trends in the life insurance and annuity marketplace?

Answer: When interest rates are at lifetime low levels as they are today, annuities and life insurance sales have to be benefited-oriented solutions to identified client needs.  There are very few interest rate-driven sales possible today.

Lifetime income riders on annuities deliver an income-longevity guarantee, and some of these same annuities or riders add higher potential death benefits too.  A few fixed annuities are offering additional LTC benefits, though these are very hard to market when rates are so as now.  The additional LTC benefits available on some single-premium life insurance contracts provide real value and real protection, and the LTC accelerated death benefits on some life contracts are also very marketable.  You have benefits when you live AND benefits when you die AND money if you quit.

How can an agent market these trends to help a 60- to 75-year-old reasonably healthy client with a life insurance need?  Use a bonus indexed annuity and immediately turn on the guaranteed lifetime income rider to pay for an indexed UL contract with a strong no-lapse guarantee.

For the first twenty years, and maybe much longer, the total benefits at death will be greater than either contract left alone, and the total cash values will be higher.  That’s better for the client, and the agent can earn two commissions—one for the annuity, and one for the life contract.  It only takes a little health, and a little love, and one CD or annuity.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – September 12

Ask the Experts!

Today’s Question of the Day is answered by guest expert, Shawn Sigler. Shawn is the Life Director at FIG Marketing.

Question: What are the most exciting product trends in the life insurance (or annuity) marketplace?

Answer: Probably the most exciting product trend in the life insurance marketplace is the explosion of indexed universal life products.  Several carriers have introduced new IULs in 2011, thus creating an even more competitive landscape in this market segment.  Also, there is talk of a few carriers who will enter this space in 2011 who’ve never had IULs in their portfolio.  Finally, the advent of guaranteed income riders on life insurance policies will definitely make for a unique opportunity in the income planning arena.

In the estate planning and wealth transfer marketplace, the concept of no-lapse guarantees is still prevalent, however we are seeing more and more advisors and clients intrigued by having flexibility in their policies – that is, having access to cash value in the form of a withdrawal or return of premium.  This is especially true for those in the 55 – 65 year old market.  Because of these client concerns, we are also seeing resurgence in whole life because of the guarantees on both the death benefit and cash value.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.