Beyond helping clients grow their assets, advisors need to know what’s available to protect their clients’ financial security and quality of life. To that end, this monthly column will look at the many risk management roles insurance can play as part of a client’s overall plan.
One versatile life product is Quantum II from The Hartford, a permanent life policy with an investment component that is structured to allow premiums to do double duty, says David Potter, senior manager of public relations at Hartford Life. Through its investment portion, the cost basis of the policy can be increased, allowing tax-free withdrawal of a greater sum. A client purchasing a policy with a $5,000 annual premium and investing an additional $25,000, for instance, will find that the life insurance contract basis puts them both together, says Potter. Thus, after 10 years the cost basis is $50,000 in premiums plus the $25,000 added up front, totaling $75,000. Life insurance tax treatment allows withdrawal of the basis first, tax free. So if the investment segment of the policy does well, the client can withdraw up to that $75,000 without paying taxes
Quantum II, says Robert Charron of The Hartford’s Nashville office and himself a CFP, can help with everything from required minimum distributions (RMDs) to the funding of buy-sell agreements, citing two real-life examples.
In the first, a client with nearly $500,000 in an IRA had a pension plan and other income and did not need to start RMDs from the IRA. He did, however, want to provide for his wife and to pass on as much money as possible to his children tax free. Says Charron, “We set the insurance premium at this year’s RMD. As RMDs will hopefully increase over time, any RMD over the amount necessary to fund the insurance will go to the investment account. If he ever needs that money back he can get it, and at his death his wife will have access to [the death benefit and whatever is in the investment account].” The policy was set up in an access trust (an ILIT, allowing one spouse access to its assets), so at his death she has access to the money; whatever is left will go to their children tax free.
In the second example, three partners in a $4.5 million business set up a buy-sell agreement. All in their early to mid-40s, they were concerned about the three major reasons for an agreement, says Charron–death, disability, and retirement. The life insurance part provides payments at the death of a partner; the investment portion takes care of the maximum non-modified endowment contract premium to fund a buy/sell. The corporation set up the investment portion as a tax-deferred sinking fund, allowing a tax-free buyout in case of disability or retirement.
David Huber, a planner in Buffalo Grove, Illinois, uses a variable product from Pacific Life that he says is similar to Quantum II. He structures it as a private pension-type arrangement by using the tax structure of the life insurance product to provide retirement benefits down the road. The client funds the investment portion for as long as possible, then withdraws up to his basis tax free. If he still needs income and no longer needs the life insurance portion, he can continue to withdraw funds–to an extent. Huber cautions, “You don’t want to take too much out of the policy so that it doesn’t support itself, or you could end up with phantom income.”