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.
For clients with non-liquid assets like a second home or a family business, life insurance offers a way to more equally divide an estate among heirs who want the property or business and those who do not, while avoiding the problems associated with converting the assets into cash.
Clients to consider for this strategy
While this is a particularly opportune time for a wealth transfer strategy, it isn’t right for all clients. In order to recommend this approach, advisors should make sure the client meets all three of the following criteria:
- A desire to leave an enhanced legacy to family, a charitable organization, or the community.Does your client have children, grandchildren or a church, community or charitable organization they would like to leave their assets to?
- Available assets that aren’t earmarked or needed for retirement income and expenses.Advisors should only consider this strategy for clients who have more than enough assets to provide the retirement lifestyle they want, plus resources to cover unforeseen risks or losses. More specifically, advisors should consider clients that have more than $500,000 in investable assets such as IRAs, annuities, bonds or CDs and/or surplus pension or social security income that is not needed for retirement.
- Healthy enough to qualify for the life insurance at a leverage point that makes financial sense.While most life insurers will underwrite up to age 90, it is generally better to pursue this strategy with clients when they are between 65 and 80. In any case, the client needs to be reasonably healthy with no serious chronic health conditions or risk factors to be a good candidate for life insurance.
As advisors have these conversations with clients, there are specific policy features they should consider.
First, for married couples, consider a survivorship policy. It is usually the best solution for spouses who do not need the life insurance benefits for each other and are using it purely as a vehicle to transfer wealth to heirs. Survivorship policies pay the benefit upon the second death and usually have substantially lower premiums than two individual policieswith the same combined face value.
Second, make sure the policy offers the ability to accumulate cash value, should a financial need or health crisis arise later in life. With this type of policy, clients will have the flexibility to (1) access the cash values on a tax-advantaged basis, (2) use the cash value to cover future premiums and eliminate the out of pocket expense or (3) reduce the death benefit to lower premiums going forward.
Finally, consider selecting a policy that offers important accelerated benefit riders like chronic illness or long term care, which are often important safeguards to have in the retirement years.
A changing landscape spells opportunity
The current opportunity for wealth transfer is clear. Market gains over the few last years and favorable estate tax laws have changed the landscape for wealth transfer. Take this opportunity to help clients reposition their recent gains, leave more money to heirs and minimize the impact of taxes on their legacy. When our current market run ends, your clients will appreciate the protection in their portfolio.