Are there hidden factors that your clients are not aware of in their financial plans that could cost them and those they care about drastic amounts of money?
How frequently should you be reviewing their life insurance policy with them? Although life insurance is sometimes erroneously portrayed as a ‘set it and forget it’ type of investment, the reality is that there are a variety of variables that can change along the way.
We have all heard of the common changes in life events, triggering updates in coverage needs or beneficiary changes. But what if the policy is owned by an irrevocable life insurance trust (ILIT) and managed by a third-party trustee?
Life insurance owned by a trust is a unique investment asset, one that requires critical attention on a regular basis. A lack of policy diligence and structured review processes can wreak havoc on policy performance, or even trigger modified endowment contract (MEC) status, which causes unexpected taxation on gains when the funds are withdrawn from a policy. An advisor in our office recently shared an unfortunate series of events that occurred within his own family.
A Real-Life Case Study
My father established trusts and purchased whole life insurance policies for my niece (25) and nephew (27) at the time of their birth. With the subsequent evolution of index universal life (IUL) products providing collared equity returns, tax-free compounding, and transparent pricing, this was truly a no-brainer, win-win exchange to IUL.
When in the final process of completing tax-free 1035 exchanges, we were first informed that these policies had been underwritten with smoker-rate charges. The policies amazingly had never been adjusted to non-smoker rates, despite annual notice to the Trust offering simplified underwriting reclassification once each had reached age 18. Worse yet, they revealed that both policies had inadvertently fallen into MEC status sometime within the first couple of years of their existence when the trust accepted an automatic policy rider that was deemed a material change.
Since it had been so long since these policies had ever been looked at, combined with limited digital records, the natural reaction is let’s find out from the broker how this had occurred…. except in this case, he had been dead for years.