One of the most common concerns clients don’t think to ask their financial advisors about is how best to transfer their wealth to the next generation. However, in many cases, clients are unaware about how their estate will be taxed and what financial tools are most efficient to pass on assets to heirs.
Wealth transfer is not a new concept. Nonetheless, the current estate tax laws and recent stock market gains have changed the landscape for wealth transfer. Now is an ideal time for advisors to talk to clients about how life insurance can help achieve their legacy goals.
The time is now
Today’s environment provides an unprecedented opportunity for legacy planning. With the stock market at all-time highs, clients in retirement are understandably concerned that their gains could be erased by a market correction, leaving them with a diminished estate for their heirs. Life insurance is an appealing solution to this problem because it provides a way to reposition gains and hedge against market volatility.
Also, now that the estate tax exemption is much higher ($5.34 million for individuals, and double that for married couples due to portability), it impacts far fewer people and no longer needs to take center stage in most wealth transfer strategies. The typical approach involves clients setting up irrevocable life insurance trusts (ILITs) and relinquishing control over life insurance policies to preserve their estates from tax erosion.
Today, many more clients can implement a flexible legacy strategy using life insurance. With this approach, they can retain ownership of their policies and access to cash values, while using the leverage and tax advantages of life insurance to leave as much as possible to the next generation.
Of course, every situation is different. Clients should consult with their legal and tax advisors to determine the best use of trusts for policy ownership and disposition of assets, as well as to get tax advice based on their own circumstances.
Why use life insurance?
Life insurance has inherent advantages over other assets that can be passed on to heirs, such as IRAs and nonqualified investments. Namely, the death benefit is a predictable, defined sum of money, and generally passes to heirs income tax-free.
Also, policies purchased by older individuals for wealth transfer purposes can have an internal rate of return on the death benefit between 6 and 7 percent at life expectancy. When you factor in the tax-free nature of life insurance proceeds and that retirees often have a conservative risk tolerance, this can be a very competitive rate of return.