Follow a checklist to help decide what to do with estate life insurance

Before recent changes in estate laws, it was common for attorneys, financial planners and insurance agents to recommend purchasing life insurance — commonly called survivorship life — in an irrevocable trust designed to provide liquidity at the death of yourself and your spouse. That was then. This is now.

Today, more taxpayers, i.e., those with combined estates less than $10,600,000, no longer have to worry about the big slice of taxes on your accumulated assets when you and your spouse pass away. The question is then — why keep the life insurance you bought for that purpose if the need has vanished?

Irrevocable trusts

The answer is not simple. Most irrevocable trusts were funded with permanent life insurance, such as whole life, fixed or variable life insurance, and later on, equity-indexed life. As an exception, 20-year or 30-year terms may have been used. Permanent life insurance is characterized by the present of accumulating cash values depending upon the level of premiums paid into the policy.

With universal life, premium levels are flexible, the minimum being the lowest amount necessary to put the policy in force. The maximum premium is set by the Internal Revenue Service. Policy owners can pay any amount in between. Higher premium levels generate more cash value or equity allowing for a paid-up policy sooner. If you currently have significant policy cash values built up, then you may have more and potentially better options to consider.

Checklist

The following is a short checklist to help one decide what to do with estate life insurance:

1. For permanent life insurance, ask your agent or broker for an “in-force ledger.” This is a projection of future policy values based on factors, such as the amount of premiums paid, interest rates, rates of return (variable life) and policy expenses. You can request a ledger showing full premiums paid, but I suggest asking for a $0 premium ledger. This will tell you how long your policy will remain in force if you do not pay premiums. For variable policies, ask for a 6.5% gross return. If you have built significant cash values to this point, then you may be able to have a policy that requires no future premiums which will last well into the future. If so, you may decide to keep the policy to provide additional liquid dollars to heirs as the annual cost would be eliminated.

2. For whole life policies, ask to see a ledger that shows a fully paid-up policy. This usually involves a reduced face amount since no future premiums are contemplated. For example, a $1,000,000 policy may be changed to a $450,000 fully paid-up policy. Or you may request an “extended term” option. This uses policy cash values to keep the face amount as it is now, but only for an actuarially determined number of years and days. As an example, you may keep your $1,000,000 face amount without premium payments for 14 years 23 days. The latter option is desirable if your life expectancies) are expected to be shorter than the extended term period. Both the paid-up and extended term options are standard with whole life.

3. Most policy owners do not realize they can reduce the death benefit all at once or gradually with a universal fixed or variable policy. If you wish to stop premiums but the policy lapses too soon, then consider reducing the death benefit immediately or in a graded fashion over time to see if the policy can remain in force longer. It usually can, but it is important to remember that once you reduce the face amount, you cannot recover it without medical evidence of insurability.

4. If you think surrendering the policy and investing the cash values makes sense — as opposed to surrendering and dispersing the cash values according to the trust provisions — run a future value projection of the cash values invested between 3% to 8%. This will show the crossover year, or the year when the accumulated cash values equal the policy face amount. If the year is sufficiently distant, i.e., reasonably close to your life expectancy or joint life expectancies, then you may decide instead keep the policy. This assumes no premiums are to be paid as an investment.

5. If you are older than 70 years and your health has deteriorated from the time you purchased the policy, and you want to get rid of the policy, then consider a “life settlement.” This involves selling the policy to an institutional buyer for a single sum, the payment being determined by your age, health, policy values and current market conditions. The buyer assumes ownership of the policy, keeping it until you die and collects the face amount. In most cases, the buyout one receives is greater than the surrender value of the policy. Term policies can be settled this way, too. Make sure beneficiaries sign off on a life settlement to avoid future legal hassles. You also will want to get together with your accountant to review the tax consequences of the settlement.

Before you do away with estate life insurance, check with your broker and financial planner to determine if there is a better alternative, such as one of those above options, than simply cashing out. Once you have the facts that quantify your choices, you can then make an informed decision. The additional values passed on to children and grandchildren are worth the effort.

Ken Rudzinski, CFP, CLU, ChFC, CRPC, CASL, CAP, a partner in the financial planning firm Heritage Financial Consultants, is a registered representative and investment advisor representative with Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor. Rudzinski offers insurance through Lincoln affiliates and other companies. This information should not be construed as legal or tax advice. You may want to consult a legal or tax advisor regarding this material as it relates to your personal circumstances. CRN-1034297-101314. Questions can be emailed to Kenneth.Rudzinski@LFG.com. He can be reached at Heritage Financial Consultants LLC, 2036 Foulk Rd., Suite 104, Wilmington, DE 19810; 302-529-1264.