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Add life lnsurance to your wealth transfer toolkit

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Advisors looking for ways to manage the explosive wealth transfer that will take place over the next couple of decades — an estimated $30 trillion will pass from boomers to Gen Y, according to consulting firm Accenture — may want to consider life insurance as a way to help clients provide stable income to their heirs.

Palmer Williams, a national sales director at life insurance consultant Saybrus, told our sister publication, ThinkAdvisor, that for the right client, life insurance can be an efficient way to pass money from one generation to the next.

“For us it all starts with the client conversation,” he said in an interview on Thursday. “When we’re part of the conversation and look at wealth transfer or estate planning, that process is built around making sure for the client that the right people get the right things in the right way.”

Those conversations may include, in addition to Saybrus and the financial advisor, clients’ family members, attorneys and tax professionals, Williams said.

“For a lot of clients — and these are clients generally between the ages of 65 and 80 who are already retired — a big part of that discussion is understanding what their goals are and what their overall financial picture is so we can help the advisor identify what we call ‘legacy assets,’” Williams says.

A legacy asset, Williams said, is an asset that isn’t needed specifically for retirement. He named four common places advisors can find assets that might not be needed and can be earmarked for an inheritance.

“Generally these assets can be found as annuities that were bought for retirement purposes but once the client is in retirement, they don’t need that annuity,” Williams said. “IRAs are obviously a big place where we can find legacy money that won’t’ be used for retirement. General non-qualified investment accounts [are another source] and then Roth IRAs as well.”

There are advantages and disadvantages to using those assets both in retirement planning and for wealth transfer purposes, Williams said.

For example, when an annuity is passed to a beneficiary, the gains inside the annuity can be taxed as ordinary income, Williams said.

“An IRA has, just like an annuity, tax-deferred growth throughout earning years and retirement years until you actually pull money out of the IRA, but upon inheritance, that IRA is going to be taxable to the heirs, who in many cases may be in their peak earning years so they may be in a higher tax bracket,” he added.

The heir’s withdrawal rate is a factor, too, “whether they stretch out the IRA or liquidate it right away.” ”Non-qualified accounts like a brokerage account are a “great place to have money,” Williams said. “Of course, you’re paying taxes on a lot of those accounts as you go. Ultimately, when you pass it along there is a step-up in basis.”

A Roth IRA, Williams said, is “an excellent place for a client to have money when they pass away. In today’s day and age, a Roth IRA is still a relatively new financial instrument, so many clients didn’t have the length of time in the work force with a Roth IRA available to build up a large balance, or they may be hesitant to do a Roth conversion with existing assets because of the potential tax hit.”

Williams noted that “it’s not that one of these vehicles is the answer and they shouldn’t have exposure to any [others], but often times life insurance can be an additional piece of the puzzle to help make wealth transfer more efficient.”

The No. 1 benefit to using life insurance as a wealth transfer vehicle, he said, is that it can provide a predictable death benefit for the beneficiary, even in a market downturn.

“If a client has a $500,000 life insurance death benefit and we come to another 2009 in the market, that 2009 may affect their other assets, but if the life insurance is structured in the right way, that death benefit still remains fixed at $500,000,” Williams explained.

Tax benefits associated with life insurance are another stroke in its favor. “As a general rule, life insurance is structured to be 100% income tax free, so that can be very appealing no matter where it’s bought, but especially if tax rates change in the future.”

A third benefit is that the rate of return compared to premiums paid can be “very competitive,” according to Williams. “This will depend upon when the client ultimately passes away, but as an example, at life expectancy a rate of return for the life insurance can be somewhere in the neighborhood of 6% to 8%.” Clients also have complete control over beneficiaries listed for life insurance and it’s easy for them to change beneficiaries, if necessary.

Finally, “the death benefit itself is 100% liquid,” Williams said. If a client has assets like a vacation home or a business, they may need to be sold to pay the benefit. “Life insurance, because it’s 100% liquid, can be an effective way to facilitate that buyout among heirs.”

Williams acknowledged that using life insurance for wealth transfer doesn’t work for everybody. There are three things that have to be present for it to be appropriate for a certain client.

First, of course, is the client’s desire to leave legacy assets to an heir. “The client has to want to leave more, to proactively plan their legacy for their family or a church or charity. Most clients do have that desire as long as it won’t affect their retirement lifestyle. There are some clients who don’t have that desire, and that’s not something we can manufacture.”

Obviously if a client doesn’t have legacy assets that aren’t needed for retirement, they can’t pass them on to their heirs, so an advisor has to take a close look at their client’s full financial picture. “Many financial advisory firms have different types of software that can help you with your modeling for clients in their retirement years, but you also want to look for some indicators. This works better for clients who already have a stable retirement picture. They may have already been retired for a couple of years. They may have pensions or a long-term care [plan] already in place to help eliminate some of the bigger threats.”

“It does involve life insurance so the clients have to be healthy enough to qualify for the life insurance,” Williams pointed out. Most insurers will underwrite a client up to age 90, Williams said, but it’s better to start when the client is between 65 and 80.  

For client couples, only one person has to qualify to be able to use life insurance as a wealth transfer vehicle, Williams said.

“With the stock market at all-time highs,” he concluded, “it’s a great opportunity to reposition some of the market gains over the last couple of years into a legacy plan.” 


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