Clients often ask us about their life insurance policies and their value to their estate plans.
We often hear, "Should I go or should I stay?"
"Should I keep my existing policies, or should I buy more life insurance to replace the wealth that may be needed in the future to pay taxes and other expenses?"
"How do you know if you have too little or too much life insurance for your estate and financial plan?"
This article will explain how you can audit your existing life insurance portfolio and determine if it is time to keep or sell your current policies. We will also explain how to know if it is time to buy more insurance in light of the proposed higher taxes and reduced estate tax exemption.
Before we get started, please feel free to familiarize yourself with the different types of life insurance, including but not limited to whole life, universal life, variable universal life, indexed universal life, or term insurance.
Also, keep in mind that the internal life insurance cash value grows income tax-free under the current law and is income tax-free to the beneficiary upon the insured's death(s).
Finally, life insurance proceeds are part of your gross estate for federal estate and generation-skipping tax. It is essential to properly title your life insurance policies (frequently, life insurance policies are owned by an irrevocable life insurance trust (ILIT) to avoid estate and generation-skipping tax).
Please take this Life Insurance Self-Audit and then call or email us with any questions about your existing life insurance plan.
LIFE INSURANCE SELF-AUDIT:
- How much life insurance do you own, and how are the policies owned? Are the policies part of your gross taxable estate for estate and generation-skipping tax, or are they held in another format, such as an irrevocable life insurance trust?
- Who are the beneficiaries of your life insurance policies? Your spouse, your children, grandchildren, or your revocable or irrevocable trust?
- Do you have a taxable gross estate for federal estate and generation-skipping tax under the current law (the federal exemption is currently $11,700,000 for each person, and under various proposals, it may be reduced to as low as $3,500,000 per person)? With or without the proceeds of your life insurance policies?
- Are your current policies healthy? When is the last time you requested an illustration from your life insurance carrier? This illustration is often called an "In-force illustration" or "In-force ledger." This means that based on the payment of the current required premiums, how are your policies performing, and when will they run out of funds to keep the policy in existence (when will the policy "lapse").
- Does your policy have any guarantees? *Note that certain policies will never lapse if you pay the required premiums. Most policies do not have guarantees but simply have projections of what the death benefit will be if all things stay the same, including mortality costs and other expenses of the life insurance policies.
- Based on the life insurance in-force illustration, do you need to pay more money than was previously suggested to keep the policy active until you or the insured (if it is not you) pass away? [Advisors commonly refer to this as a life insurance policy audit.]
- Do you own or do your family members own enough life insurance to provide wealth replacement when the proceeds from the insurance are needed? *Often referred to as wealth replacement insurance, and the trust holding the life insurance is often referred to as a wealth replacement trust. What is the wealth that it is replacing? Is the wealth necessary to pay estate taxes, income taxes, generation-skipping taxes, pay for final expenses (including end-of-life medical expenses), and, finally, enhance or replace the funds passing to your favorite charities?
- Suppose you do have an anticipated federal taxable estate for estate and gift tax purposes. Do you have enough remaining annual exclusion gifting or federal estate and generation-skipping exemption to support your required future premiums? *Often, as part of the estate plan, we will set aside (in advance), inside of an ILIT/Wealth Replacement Trust, enough funds or income-producing assets to pay for all future insurance premiums. This is extremely important if the estate tax exemption is reduced.
- Do you wish to dispose of your existing life insurance policies because you no longer need the wealth replacement aspects of your life insurance? What option should you choose? Should you:
- Let the policy lapse and simply stop making the premiums?
- Cash in the policy and take the cash surrender value often with penalties?
- Sell the policy to a third party in a "life settlement" transaction?
- Borrow the funds to pay the future premiums in a "premium finance" transaction?
Sometimes, there is enough cash value inside the policy to pay for the internal cost of keeping the policy, and you can reduce your annual outlay and let the cash value pay the annual insurance costs.
- Are the beneficiaries of your respective life insurance policies current for future asset preservation for your heirs? Ex. are the proceeds payable to your estate, your revocable trust, an ILIT, or outright to your children, grandchildren, or other heirs?
- Would you like to consider donating all or a portion of your life insurance policies to your favorite charities to create a sustaining and impactful legacy? This is especially useful for policies you are considering discontinuing the life insurance coverage due to your change in financial circumstances.
Life Settlement is on the rise, and often companies that invest in buying life insurance policies will contact you and ask you if you wish to sell your policy. Often, they offer a number that might be significantly higher than your current cash surrender value.
Beware, if these investors want your policies, there is a reason. The policies are far more valuable than the current cash value plus all future required premiums.
We often say if they want it so badly, why not keep it yourself.
If the answer to many of these questions is "I do not know,” an expert in the field can do a life insurance audit. Please call us if you have any questions or wish for our assistance in obtaining an appropriate life insurance plan evaluation.