|
Using Universal Life Insurance with
Secondary Guarantees for Estate Taxes
As things stand in early 2007, estate and generation skipping
(GST) taxes will be repealed in 2010 and reinstated in 2011. And
given that Democrats now have control of the House and the
Senate, experts are predicting that the permanent repeal of the
estate tax is unlikely in the next two years.
At present, for
2007 and 2008, the estate tax exemption is $2 million per
person, rising to $3.5 million in 2009, repealed in 2010, and
then the tax returns in 2011 with an exemption of $1 million.
Given existing laws, experts suggest that using life insurance
to pay for potential estate taxes is a very viable solution.
According to industry reports, the number one product sold for
estate liquidity today is universal life with a secondary
guarantee. In short, this is a policy whereby insurers guarantee
the insurance benefit on a universal life insurance policy even
if the cash value in the policy goes to zero. This is known as a
"secondary guarantee." The policy owner agrees to pay
a premium which is often less than a whole life insurance
premium and if the policy owner keeps up payments, the policy's
death benefit is guaranteed to age 100.
Policies with secondary guarantees are often used for estate
planning where the crucial component is a guarantee of the death
benefit and cash value build-up is secondary.
Survivorship life insurance (also called joint and survivor
life insurance or second-to-die life insurance) can also be used
for estate planning to create the cash liquidity to pay the
estate taxes. However, in order for the insurance death benefit
to avoid both income and estate tax, the policy must be set up
properly within an Irrevocable Life Insurance Trust (ILIT).
So what in general is universal life, what are its advantages
and disadvantages, and when should it be used? According to
Tools and Techniques of Life Insurance Planning, universal life —
which was first introduced in the late 1970s — is often
referred to as a "flexible premium," "current
assumption," "adjustable-death-benefit" type of
cash value policy. It's flexible premium because the policy
owner can pay whatever premium they wish within a given range
and adjust later as needed. Policy owners can even skip premium
payments provided there's enough cash value in the policy to
cover policy charges. It's called a current assumption because
current interest rates and current mortality and expense charges
are used to determine the cash value of the policy. And it's
called an adjustable death benefit because the policy owner can
lower the death benefit at anytime and can raise it with
evidence of insurability.
Given this flexibility, universal life is a useful product
should a person's estate tax liability rise or fall with the
Congressional tides. Typically, a universal life policy is best suited
for long-term coverage needs; while a non-renewable term policy
will generally be more cost-effective for short-term needs.
Generally, however, such policies work best when flexibility is
needed and policy owners need to reconfigure their premiums or
death benefits.
According to some planners, the biggest
advantage of using guaranteed universal life is this: The policy
owner pays the least expensive premiums to guarantee a lifetime
death benefit. The policy owner can also adjust the premium. If,
for instance, there's enough cash value to cover the mortality
charges, the policy owner could even skip premium payments.
However, caution should be followed in skipping or delaying
payments on these contracts since the "guarantees"
could be impacted. Even premiums received during the grace
period could affect the accumulated values and
"guarantees." Policies differ on this and need to be
reviewed before any change is to be made.
The policy is also
transparent — the policy illustrations and annual reports break
out and report each element of the policy, such as premium,
death benefit, interest credits, mortality charges, expenses and
cash value, separately.
Universal life policies also offer two
death benefit options, one that is similar to a traditional
whole life policy and one that is like a traditional whole life
policy with a term rider. The first, a level death benefit; the
latter, an increasing death benefit.
When selecting a universal
life policy, it's especially important to consider the amount
credited to cash values. The prospective policy owner should
know how the insurer determines the amount credited to cash
values. The amount credited to cash values depends on the
expenses charged against the policy, the mortality charges
assessed against the policy, net investment yield earned by the
insurer on its portfolio investments and the method used to
allocate interest to various blocks of policies.
February 2007 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
|
