The economic downturn has heightened the concern of readers who already have life insurance but are having difficulty continuing premium payments. The same concern—high premium costs—confronts readers who need (or want) new policies.
Part I (June MMS) dealt with existing policies. This column—Part II—explores "the how to" for new life insurance policies. The trick is to acquire the desired death benefit amount, from top-rated insurance companies, but pay substantially less in annual premiums, from inception until the day you die.
The trick is easy to do once you know how. We do it for readers of this column on a regular basis.
Depending on your age, health, specific goals and the type of assets you own, the trick is successfully performed by selecting the right strategy or combination of strategies. Following are the five key strategies we use most often when a client buys new insurance. Unless otherwise indicated, all policies have cash surrender value (CSV).
1. Financed insurance. You use cash, marketable securities (stocks and/or bonds) or real estate as collateral for bank loans. The loans are used to pay your premiums (and interest on prior loans).
For example, Joe (age 62) and his wife Mary (age 59) bought $5 million of second-to-die life insurance. The annual out-of-pocket premiums are only $16,500. Joe simply pledged $300,000 of his $1.6 million stock portfolio as collateral with the bank. Normally, the premiums would be about $63,000 per year. The bank loans do not have to be repaid until both Joe and Mary have died.
This financed-insurance strategy is the best tax-advantaged opportunity (legally allowed) that I have seen or heard of in my 40-plus years as a tax practitioner. It is implemented in combination with an irrevocable life insurance trust (keeps insurance proceeds out of your and your spouse's taxable estate). You actually create tax-free wealth—millions of dollars—with minuscule out-of-pocket costs. You must check it out.
2. Subtrust. If you have funds in a 401(k), profit-sharing plan, IRA or other qualified plan, you can create a subtrust. You will not pay any premiums. Instead, the subtrust will pay all premiums. In effect, you have deducted your insurance premiums and used the profits earned in the plan to pay your personal premium expense . . . tax-free.
3. Family limited partnership (FLIP). You create your FLIP by transferring income-producing property you own (for example:stocks, bonds or real estate) to it. It's a tax-free transfer. A FLIP has many estate planning advantages. Its income is used to pay the insurance premiums. Your heirs will get the life insurance proceeds free of income and estate tax.
4. Defective trust. Such a trust is defective for income tax purposes. (It is treated as if it does not exist.) But the trust is recognized for estate tax purposes, and like a FLIP, it has many estate planning advantages. The property you own is sold (instead of transferred, like a FLIP) to the defective trust—a tax-free sale. The income pays the policy premiums. And of course, the life insurance proceeds are free of income tax and estate tax.
5. Combinations. The above strategies are often combined with term insurance and an irrevocable life insurance trust.
The above does not attempt to cover all of the possibilities for slashing your premiums when purchasing new life insurance policies, nor does it cover all of the rules and tax traps for those who attempt to use the strategies without professional help.
Rather, the purpose of this column is to show you some of the many possibilities for creativity when buying large amounts ($1 million or more) of life insurance. If you or your professional advisors need help to start the process, you are welcome to call me and I'll point you in the right direction.