Beat the Tax Collector with Good Health

Surviving for five years after a major health issue—cancer, stroke, cardiac arrest—can reduce your insurance premiums.


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A full-page ad in a national weekly magazine stopped me cold. The ad read: “Five years after you quit smoking, your risk of stroke is similar to someone who’s never smoked.” Below were these terse words: “But right now, you’re a STROKE waiting to happen.” The accompanying photo depicts a senior male sitting alone in a wheelchair facing a shaded window. You see only his back, shoulders and bowed head. The message is clear.
The ad phrase I want to focus on is “five years.” Just as your risk of stroke after quitting smoking for five years is the same as someone who’s never smoked, your life expectancy after surviving cancer, heart attack or stroke for five years is the same as someone who’s never experienced such an event. 
I can relate. Many years ago, I struggled through two bouts of cancer—scared the “H…” out of my family—and celebrated after each magic five-year period. Now, I’m a young octogenarian.
So what does all of the above have to do with estate planning? Plenty!
Clients’ life expectancies are always a significant consideration for an estate planner. This is particularly true when planning for retirement and business succession. Your age, health and smoking habit are the three most important factors in determining your life expectancy.
Strokes, cancer or heart attacks can never be anything but bad news. But Hallelujah! Survive for five years, and your life expectancy is probably statistically the same as the general population of Americans. You are considered “standard risk” by insurance companies.
Standard risk classification is a rating life insurance companies use to determine premium costs. This rating means your life expectancy is the same, on average, as other Americans who are the same age and sex.
Life insurance plays an important role in most estate plans, but no life insurance company wants your money if it doesn’t think you are going to live. However, if you survive the five years, the insurance company will take your money and issue you a policy that will enable you to pay the same premiums as a healthy person of the same age and sex. Sadly, most people don’t have a clue that the five-year rule exists.
The following examples use the five-year rule in estate planning to enhance the wealth of each client without losing a penny to the IRS.
• Second-to-die coverage. Joe, 58, is a cancer survivor of eight years and married to Mary, 58. Today, both are healthy and considered standard risk. They need $2 million of insurance coverage for estate-tax purposes. No estate tax is due until the second person dies, so second-to-die insurance is the perfect choice for them. Best of all, it costs less than single coverage, which is $18,200 per million dollars for Joe and $16,210 for Mary. Second-to-die insurance, on the other hand, costs only $10,202 per million. This coverage is available only because Joe is now insurable. Of course they buy $2 million of second-to-die coverage. Bless the five-year rule.
• Individual coverage. Sam, a 65-year-old widower, owns Success Co., which he wants to transfer to his son. Sam has two non-business children whom he wants to treat equally. He needs $3.5 million of insurance, together with his other assets, to reach the equalizing goal. Although Sam suffered a heart attack in his late 40s, he passed his insurance physical. Sam uses the funds in his rollover IRA to pay the annual $85,302 premiums on a $3.5 million life insurance policy to solve an estate-planning problem he originally thought had no solutions. Once again, the five-year rule saves the day.
The five-year rule has a kissin’ cousin: the two-year rule. This rule is used when the insured is healthy enough to be insurable, but is a smoker. Remember, insurance companies do not want your money if they think you are not going to live. Smokers die sooner than non-smokers, so the premiums for smokers are always higher.
Now here’s an inside secret that few professional advisors know: Most insurance companies will consider a rate reduction (from smoker rates to non-smoker rates) after two years of documented smoking cessation. Here’s a real-life example:
• Quit smoking for two years. Jack, 42, is healthy, but he smokes. Jack needs $1.5 million in life insurance to fund a buy/sell agreement. ABC Insurance Co. rates Jack a standard risk, but charges him a smoker’s rate: $18,586 per million for his new $1.5 million policy. The non-smoker’s rate would have been $9,901. After two years of abstaining from any kind of nicotine product, Jack provides documented proof that he is nicotine free. ABC lowers his annual premium to $10,795, the rate for a 44-year-old non-smoking male. The usual physical necessary to buy insurance was not required.

Sadly, the interaction of economics, the way insurance companies do business and the tax law make this area overly complex. Knowing the right strategies to implement puts you in a position to beat up the IRS with affordable life insurance to enrich your family.