In the year since the market crash of October 2008, many high-net-worth investors–many of them baby boomers–have undergone a revolutionary change in perspective. Many have lost confidence–and substantial wealth.
A good number of these investors may never be comfortable again entrusting their retirement and their estate to a strategy centered on the growth of an equity portfolio and real estate holdings. They no longer have as much appetite for risk and are much less comfortable taking on substantial debt; the need for liquidity is becoming paramount. The prospect of higher estate taxes in the next decade is also looming.
Due to some of these monumental issues, there has been a resurgence of interest in whole life insurance. The product offers individuals both permanent and guaranteed death benefits, along with a guaranteed savings component. These policy values can be accessible to individuals who might need to draw down on them in these hard times.
For example, boomer high-net-worth investors who only 18 months ago regarded life insurance planning to be something of an afterthought may now be re-evaluating their plan’s function. For more investors, a well-crafted life policy is now the cornerstone of a long-term financial strategy.
While considered primarily as basic protection, life insurance is now also viewed as an essential, conservative cash component. Some life insurance products, such as whole life, can provide risk-averse ways to accumulate assets in a tax-deferred manner while also insuring clients. Insurers typically accomplish this by investing premiums in fixed income investments at the low end of the risk spectrum.
A change in philosophy
A sign that investors are reconsidering how best to use their life insurance plans is visible in the increasing popularity of whole life insurance (that is, permanent insurance plans) over term life insurance plans. The economic meltdown is fueling this trend. For example, an investor who in his 30s had purchased a 20-year-term policy, expecting to be self-insured by the time he hit his 50s, may be regretting that decision after surveying the ruins of his portfolio. A permanent plan, offering lifetime protection, may be far more appealing now.
Many high-net worth investors may now find themselves with a liquidity crisis, particularly if much of their worth is tied to underperforming stocks or real estate. Debt is also a growing concern. Like many Americans, high-net-worth investors are increasing their savings while trying to make their debt more manageable.
Consider an investor who carries a significant mortgage on a house, believing the property would appreciate in value and, when sold, would more than cover the outstanding loan. If not, the equity portfolio would handle it. Given the economic downturn, this belief may now seem unfounded. But, again, life insurance can be a key tool. For example, a policy designed to pay off an outstanding mortgage upon a spouse’s death has a clear appeal for investors concerned that their estate will be decimated by debt obligations.
A change in strategy
There are several long-term strategies for which investors can design insurance plans: (1) to compensate for a decline in wealth (by purchasing a policy that would replenish any depreciated assets upon the death of the insured); (2) to provide liquidity and protection to surviving spouses; and (3) to reduce the tax burden on heirs. Among the strategies that may work best in these economic times are the following:
Irrevocable Life Insurance Trusts as income transfer station.
Clients can work with an attorney to craft an irrevocable life insurance trust (ILIT) with the ultimate goal of removing money from their estate to flow estate-tax-free down to their heirs.
For example, assume a couple buys a $5 million policy within an ILIT and one spouse subsequently dies. The policy is then paid to the trust, rather than to the surviving spouse. The trust provides the surviving spouse with a lifetime annual income. Upon that spouse’s demise, whatever money remains in the trust passes to the couple’s heirs protected from estate taxes.