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Life Health > Life Insurance

Using Life Insurance To Stabilize Wealth Transfer

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When used in the right circumstances, a life insurance death benefit offers clients a tax-advantaged mechanism to provide a guaranteed inheritance to beneficiaries, regardless of the performance of their non-life insurance investment portfolio.

Protecting against portfolio underperformance

The leverage offered by the death benefit of life insurance, relative to premiums paid, has long been used for annual exclusion gifts, generation-skipping tax exemptions and credit shelter trusts funded following the death of a first spouse. In all cases, life insurance allows dollars paid as premiums, at least in the early years, a death benefit generally far in excess of the premiums paid. Ultimately, clients must conduct an internal rate of return (IRR) analysis.

The IRR–readily available from any illustration system–is a way to measure two unlike streams of cash outflow and inflow by equating them to an interest rate. Where the IRR using life insurance exceeds what a client might achieve compared to another approach, life insurance may be a viable alternative use of funds, especially considering the survivor protection it also provides.

Weighing the pros

Moving a small piece of the portfolio, or income, annually into a life insurance policy offers a client a significant death benefit in relation to the premiums paid, especially in the early years.

The death benefit transfers a fixed amount to the client’s beneficiaries. The effect may be to reduce the loss associated with a client’s portfolio, especially if the cross-over with the non-life insurance assets occurs after a client’s life expectancy. Even if the cross-over point occurs a few years before a client’s life expectancy, a client still obtains the death benefit and protection in all years, as long as the policy is in force.

Knowing their beneficiaries will receive a fixed amount, clients might be able to take a different approach to their non-life insurance assets; they might either become more aggressive or more conservative.

If properly owned, the death benefit can be received free of estate tax and income tax-free.

Weighing the cons

Directing funds to premiums will reduce the return on a client’s underlying portfolio. If clients live beyond the cross-over point, they might find they would have been better not purchasing life insurance, although this may be mitigated by the policy design.

A client’s purchase is determined based on their medical and financial underwriting. Depending on the individual, the purchase might be limited.

A client’s ability to see this plan to fruition is based on the claims paying ability of the insurance carrier to meet continued premium payments.

Premium payments & policy design

Two important factors to consider when using life insurance to stabilize investments are premium payments and policy design.

Clients may fund a policy a number of ways. They can pay for a personally-owned policy via personal funds or a third-party loan. Where a policy is owned outside a client’s estate, they fund premiums via annual gifts, private loans to a trust or family member, or third-party loans.

Clients with liquid assets may wish to make annual gifts or private loans. Clients with illiquid assets may prefer to use third-party loans. (Using third-party funds might reduce a client’s overall cash outflow and boost the IRR a client achieves on their overall insurance purchase.)

The premium payment structure in a modern universal life policy might vary according to a client’s individual cash flow needs and overall life insurance planning. Additionally, the use of a carrier’s high early cash value rider might boost policy cash values and reduce a client’s outside collateral.

For an additional cost, a return of premium rider (ROPR) permits clients to provide a death benefit that allows beneficiaries to receive both the intended death benefit plus a return of the expended funds. The added benefit can be either some or all of the premiums expended toward the premium expenses, or it may include an interest rate to compensate for the lost use of funds. Depending on the policy design, a client and insurance advisor may be able to enhance what ultimately passes to the beneficiaries.

An ROPR can be added in one of two broad designs:

A flat death benefit is selected and the ROPR boosts the death benefit to assure that all expended funds are returned–a common approach with third-party financing to assure that the clients do not erode the death benefit by paying off a loan. This approach adds to the cost of the life insurance, but ultimately funds are returned, or loans are repaid.

Alternatively, a client and insurance advisor might determine that they only want to commit a fixed amount each year, perhaps pegged to a percentage of the client’s net worth. Purchasing a fixed death benefit, a client will start out with more death benefit but never see an increase. A variation would be to purchase a lower death benefit but add to the policy each year: (1) a return of premium amount; or (2) a return of premium plus a lost use of funds rate.

Both offer lower initial death benefits and IRRs, but, over time, the death benefit grows and compounds. The latter will start out the lowest of all options, but because the death benefit compounds as the lost use of funds interest rate compounds, death benefit and IRR have the potential to grow substantially over time.

Where clients believe they will live below their life expectancy, the level death benefit is the optimal choice. For those who think they will meet or exceed their life expectancy, an ROPR or ROPR plus a compounding interest rate, may make more sense.

Key takeaways

? Life insurance can offer a strategy to protect client inheritances simply through the use of the death benefit paid to beneficiaries.

? The death benefit can have a stabilizing effect in the face of a potentially widely fluctuating portfolio.

? Premium payments and policy design can enhance the ultimate effect to a client and his or her beneficiaries.

Mark Teitelbaum, JD, LL.M., CLU, ChFC is vice president, advanced markets, independent distribution, at AXA Equitable, New York, N.Y. He can be reached at .


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