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Why cash value life insurance may be the estate planning tool your clients need

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Even with the stock market reaching new highs recently, some investors are still reeling from the memory of the economic downturn of the previous decade and its aftershocks.  As a result, there is a segment of investors who are risk-averse and have turned to low-yielding assets such as certificate of deposits (CD), money markets and cash. If investors have assets earmarked for their heirs in a CD, they may have sought the relative safety of this fixed interest vehicle. After all, many investors want to at least preserve the amount set aside for heirs.

The cost for this safety is a very limited potential for growth in today’s low interest rate environment. The national average for CDs changes from week to week and varies according to duration. The rates are relatively low by historical standards, sometimes dipping below 1 percent. These low rates of return, compared with the current modest inflation of 2 percent to 3 percent, mean CD assets often lose buying power in today’s planning environment.

For those with sufficient net worth and annual income, and for those who truly do not need the CD or other asset for retirement income, is there another option providing a reasonable way to reposition your assets that has potential growth greater than current fixed interest rates? Absolutely. Many clients can activate their assets by repositioning part of the low-yielding CD or other low-yielding asset to life insurance. 

This strategy can provide the following benefits:

  • Preservation of capital for children, grandchildren, or a favorite charity.
  • Potential for competitive rates of return on life insurance cash value to withstand buying power erosion.
  • Death benefits to her heirs based upon the claims-paying ability of the insurer.
  • In some cases, optional riders permitting access to accelerated death benefits triggered by chronic illness.

Life insurance contracts vary in terms of benefits and features, amount of death benefit, and crediting methods with respect to cash value. The actual death benefit and other benefits depend upon age, health and premium amount, among other factors.  Anyone considering this strategy should carefully consider the specific life insurance features and benefits being purchased in light of their overall planning needs and objectives and consult with their financial advisor and/or tax advisor prior to implementing this strategy.

In general, this strategy works best for people who:

  • Are at least age 59 ½ + and family-oriented.
  • Have sufficient net worth and liquid assets to support this strategy.
  • Hold a CD or other low-yielding asset not needed to support financial goals in retirement.
  • Have sufficient retirement income from other sources, besides the CD or other low yielding asset.
  • Have a financial plan completed by a financial advisor.
  • Have a desire to provide for children, grandchildren, and/or charity and consider the CD or other low yielding asset as a “leave-on” asset for them.

Let’s consider Cathy Smith, a 60-year-old retired executive who was recently widowed. Cathy has $2 million in net worth, she has adequate income from her pension, her husband’s pension, Social Security and other investment income to easily meet her expenses and, in fact, she often has significant disposable income. Cathy is a saver.  She has a $200,000 CD currently yielding 1 percent. This money is earmarked for her granddaughter, Mary.  Cathy is interested in providing more for Mary. Cathy also wants the opportunity for her money to grow at a rate exceeding the 1 percent her CD currently yields.

After consulting with her financial advisor, Cathy decides to liquidate the CD over a period of five years. She purchases a cash accumulation life insurance policy with five annual payments of $40,000 for a total of $200,000 of premium payments. Assuming Cathy is very healthy and assuming a 4.10 percent crediting amount to the cash value portion of the policy, the five payments of $40,000 can purchase $585,000 of death benefit and include a chronic illness rider. 

The chronic illness rider will permit her to access cash from her policy, if she is deemed to be chronically ill under the terms of the rider, by accelerating the death benefit.  Benefits which would be received under a chronic illness rider are generally received income-tax free. This means Cathy would have an additional pool of money in the amount of $585,000 to offset expenses if she is deemed to be chronically ill under the terms of the applicable rider. 

In addition, the cash value inside the life insurance policy will have the potential to grow at a higher rate than was possible in the CD. Crediting rates and methods vary from policy to policy and are subject to changes by insurance companies. That said, in many cases, even conservative crediting rates exceed the 1 percent Cathy was receiving in her CD. In this hypothetical, the crediting rate of 4.10 percent is far better than the 1 percent she is yielding in the CD. If her needs change over time, Cathy may access the policy cash values through loans and/or withdrawals if her needs change and she decides to use cash values to supplement those needs. Of course, any loans or withdrawals taken from her policy will lessen the remaining amount of the death benefit meant for Mary.

When she passes away, Mary will receive her life insurance policy income-tax free. Upon Cathy’s death at age 86, the death benefit would be $585,000 for Mary, significantly more than under Cathy’s original approach of leaving the CD to Mary.

It is important to note that if Cathy or anyone needs the CD or other low yielding cash asset for short-term cash needs or for retirement purposes, then this strategy does not make sense and some other strategy would need to be considered.  However, if the assets are not needed for retirement and are earmarked for heirs, then exploring this strategy makes sense and should be considered.

By repositioning the assets not needed into life insurance, people can increase what their heirs receive, can have the potential for more growth inside the cash value policy and, through chronic illness riders, have access to the entire death benefit to offset expenses during a period of chronic illness. These benefits may be significant reasons for many people to re-evaluate their low yielding assets, and to work with their advisors to activate those assets to better accomplish their financial goals.