By Philip J. Kavesh, J.D., LL.M. (Taxation), CFP®, ChFC, California State Bar Certified Specialist in Estate Planning, Trust & Probate Law | Volume 2, Issue 6 (June 2014)
Now that fewer than half of one-percent of all estates face a potential estate tax, I have had life insurance agents (as well as financial planners, CPAs, and attorneys) ask me whether there’s any need for life insurance anymore in clients’ planning, beyond the still standard needs for replacing the income of a head of household or funding a business partner buy-sell agreement.
Over my 30+ years of experience in advising clients on estate, tax, and financial planning, I have seen and utilized many opportunities for life insurance that many practitioners overlook and continue to apply. Here is just five of them.
Overlooked Use of Life Insurance #1: Equalizing Inheritances
Most of the wealthy clients that I have encountered have become that way because they own rental real estate or a business. These assets create havoc with their estate plans. They often want one or more children to receive these assets and the remaining children to receive some equalization in terms of value, but there is not enough cash or other investments (or we cannot assure the client that there will be enough to equalize the inheritance when the time comes). The clients don’t want the beneficiaries who receive the real estate or business to be saddled with debt to equalize the others’ shares of the estate. Life insurance is a great idea in this situation. It does need to be explained as an “imperfect” solution, because the policy proceeds may not exactly match the value of the business or real estate at death. But the good news is that there’s no need to over-insure either because the insurance proceeds will be immediately liquid and will be income tax-free, unlike the business or real estate, which to become liquid may have to be sold and be subject to capital gains taxes. An educated guess as to the amount of insurance needed can be adjusted over time (depending on the policy) and is way better than doing nothing.
Overlooked Use of Life Insurance #2: Avoiding World War III Between the Brady Bunch
More and more, we are encountering “blended families”, where we see one or both spouses with children from a prior marriage. (See, “LEIMBERG LIBRARY: Tools & Techniques Estate Planning for Modern Families, 1st Edition”) The estate planning for these couples often still includes Exemption and/or Marital (or “QTIP”) Trusts – – even though not needed for estate tax purposes – – in order to assure that each spouse’s portion of the estate will eventually pass to his or her children. The surviving spouse is usually entitled to some or all of the income (and possibly has a vested interest in principal) of the Exemption and/or Marital Trusts so the surviving spouse can be adequately taken care of. Meanwhile, the “remaindermen” (the children of the deceased spouse) hover threateningly over the shoulder of the surviving spouse, constantly questioning every investment, expense, and distribution, while seemingly “rooting” for the surviving spouse to pass away so they can get their inheritance. This is a living hell, or World War III between the surviving spouse and the Brady Bunch kids. When explained this way to the clients, they will often opt to acquire life insurance, so the deceased spouse’s family gets either the estate or insurance death proceeds and the survivor and his or her family get the rest – – so never the twain shall meet (and do battle)!
Overlooked Use of Life Insurance #3: Good Kids Become Bad Partners
This is a variation on Overlooked Use #1, equalizing inheritances. Here, the parents’ estate is again comprised mainly of real estate or a business. However, instead of designating one or more of the children to get them as specific bequests, the parents want all the kids to share the estate assets equally. “They all get along and I want them to get equal shares. They can work together.” Well, I have responded, “You know what they say, ‘When the cat’s away, the mice will play!’ You’re forcing your kids to be partners (under the influence of their spouses) and guess what will happen? They can’t agree on how things will be handled. Or, one will want cash (or need it, such as because of a divorce or creditor issue) and force a sale at a ‘fire sale’ price!” (By the way, though theoretically these issues can be addressed by an LLC or FLP agreement, that doesn’t keep the conflict from occurring or the aggrieved child from testing the agreement in court!) Life insurance is an excellent way to generate enough cash so that certain “partners” can be bought out when the need occurs.
Overlooked Use of Life Insurance #4: Incentivizing “Right” Behavior of the Younger Generation While Also Protecting Their Standard of Living
I have found many clients are more concerned about the future of their grandchildren than of their children. The standard of living in this country, whether we like to admit it or not, has gone down. Grandchildren face a much harder time financially than prior generations, in buying a home, going to college, starting a career, or opening up their own business. The grandparents can either rely on their children to provide properly for the grandchildren (from what’s left from their inheritance!) or can set up a “family bank” directly for the benefit of the grandkids. This family bank is simply an irrevocable trust, holding an insurance policy, the proceeds of which can be discretionally distributed or loaned to the grandchildren for worthwhile pursuits, like buying a home, going to college, starting a career, etc. Criteria or guidelines for these discretionary distributions or loans can include good grades, earning a degree, matching outside income or savings, etc. If the insurance cannot be placed on the lives of the grandparents, the children may be ones that are insured. Grandparents love this family bank approach!
Overlooked Use of Life Insurance #5: Securing Much Needed Long-Term Care Coverage
Rarely do I encounter clients who have adequate long-term nursing care coverage. They think their assets can pay for it, but have they seen the real cost of long-term nursing care? It could be hundreds of thousands or even over $1 million. Or, they think that the government will pay for it. WRONG! (Unless maybe they qualify for Medicaid). Clients also often think that a policy may be too hard to get or is too expensive, which is probably the right assumption if they only look at traditional long-term care insurance policies.
What they may not know is that there are now “hybrid” forms of life insurance policies that can provide significant long-term care benefits but are often easier to qualify for and less expensive than traditional policies. Better yet, many clients have old life insurance policies sitting around that can be exchanged tax-free into a newer hybrid policy, sometimes with little or no ongoing out-of-pocket premiums! And best of all, unlike traditional long-term care insurance policies, where it’s “use it or lose it” and the insured and his or her family get nothing back if the long-term care costs are not incurred, the hybrid policies provide an income tax-free death benefit! If the client is under age 75, this is a really good life insurance option worth looking into.
This is one of a series of articles revealing commonly overlooked uses of life insurance by estate planning professionals of all designations.
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ABOUT THE AUTHOR
Philip J. Kavesh is the principal of one of the largest estate planning firms in California – – Kavesh, Minor and Otis – – now in its 33rd year of business. He is also the President of The Ultimate Estate Planner, Inc., which provides a variety of technical training, marketing and practice-building products and services for estate planning professionals. If you would like more information or have a question for him, he can be reached at email@example.com or by phone at 1-866-754-6477.