Life Insurance Is An Asset In A Class By Itself

? having growth/leverage potential

? being subject to government oversight

Properly structured life insurance policies have all these features. As an asset for efficiently transferring family wealth, life insurance is in a class by itself. Affluent individuals and families often use life insurance as a component of their wealth transfer plan because it can deliver this unique combination of advantages.

Nevertheless, even after learning about all its potential advantages, some people remain skeptical about using some life insurance. They may want proof that it will be financially efficient for them.

Over the years, internal rate of return analysis has become accepted as a reliable way to measure financial efficiency. With life insurance, the IRR is the interest rate at which the premiums paid into a policy will have to grow to equal the death benefit paid out when the insured dies. A number of companies have software illustration programs that allow them to make IRR calculations.

Good IRR software programs consider the fact that life insurance death benefits are generally paid out income tax-free. Based on the insured’s marginal income tax bracket, these programs will compute the annual after-tax interest rate at which the policy premiums would have to grow to equal the policy death benefit.

Because it is impossible to know the year in which the insured will die, IRR computation programs usually compute IRRs for a series of years. Such a range of IRRs can be confusing for clients. Although it is possible the insured could die anywhere within the range, advisors often advise their clients to focus their attention on the IRRs for the years near the client’s life expectancy.

Some companies are currently using the 2001 CSO mortality table to measure an insured’s life expectancy. The IRR for the life expectancy year (and those within 5 years on either side of it) can tell the client how that particular policy might perform and how effective it might be in transferring wealth to policy beneficiaries. Clients must decide for themselves what constitutes an acceptable internal rate of return in years close to life expectancy.

Application of IRR

Let’ apply the IRR to a specific case. We’ll consider James Smith, a 65-year-old man in standard health who is considering the purchase of a policy on his own life with a $1,000,000 death benefit. A policy issued by the insurer with a $26,000 annual premium produces these IRRs and tax-adjusted IRRs, as illustrated in the chart.

Since Mr. Smith’s life expectancy is age 85, he would be wise to examine the IRRs and tax-adjusted IRRs computed for that year, as well as those in years close by. The 8.17% tax adjusted IRR rate is very good and the unadjusted rate of 5.88% is also strong. Hopefully Mr. Smith will agree that at this time and in this economy, these IRRs indicate that life insurance can increase the efficiency and effectiveness of his wealth transfer plan.

When it comes to transferring wealth, life insurance is in a class by itself. This asset can help many clients pass on more of their net worth. And because death benefits are paid in cash, it can be used to accomplish many objectives. Some of your clients might benefit from adding a life insurance component to their wealth transfer plans. Show them how life insurance may help them increase the income tax efficiency of their plan and transfer more of their wealth to their family.

Peter McCarthy, JD, CLU, ChFC, is a senior advanced sales consultant on Life Sales Support Team at ING Americas-U.S. Financial Services, Windsor, Conn. His email address is [email protected].