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Life insurance is a unique asset which is used to solve some of life's perplexing financial problems due to its potentially high yield and its tax-favored benefits.
Life insurance can be used to:
Create an estate. Where time or other circumstances have kept the estate owner from accumulating sufficient assets to CAE for his or her loved ones, life insurance can create an instant estate.
Pay death taxes and other estate settlement costs. These costs can vary from a low percentage of three to four percent to over 50% of the estate. Federal Estate Taxes are due nine months after death.
Fund a business transfer. Business owners often agree to buy a deceased owner's share from his or her estate after death. Life insurance provides the ready cash to finance the transaction.
College fund for children or grandchildren. Cash value increases, in a policy on a minor's life or the parent's life, can be used to accumulate funds for college.
Pay off the home mortgage. Many people would like to pass the family residence to their spouse or children free of any mortgage. Often a decreasing term policy is used, which decreases in face amount as the mortgage balance is paid down.
Protect a business from the loss of a key employee. Key employees are difficult to attract and retain. Their untimely death may case a severe financial strain on the business.
Create a retirement fund. Current insurance products provide competitive returns and are a prudent way of accumulating necessary funds for retirement years.
Replace a charitable gift. Charitable Remainder Trusts provide tax benefits and life insurance can replace the value of the donated asset. Policies can also be paid directly to a charity.
Guarantee loans. Personal or business loans can be paid off with insurance proceeds.
Equalize inheritances. When the family business passes to children who are active in it, life insurance can give an equal amount to the other children.
Who will be the owner of the Policy?
Life insurance proceeds are included in the estate of a deceased of he or she has any "incidents of ownership" in the policy. Ownership by adult children or an Irrevocable Life Insurance Trust should be considered if there is an estate tax problem.
How much life insurance?
This will depend on the need it is fulfilling. Amounts needed to fund a business transfer or to pay death taxes may be readily determined. Calculating the value of a human life to a family is more difficult. Consider these projected total earnings up to age 65 assuming a 5% annual increase including inflation:
What type of policy should be purchased?
A person trained in life insurance can explain the many different policies available and assist in selecting the one which best fits your needs.
How should the premium be paid?
Sometimes the amount of the premium can be paid from current income, while other times it may be prudent to reposition other assets so as to be able to acquire sufficient insurance protection.
If the insured is a business owner or executive, a corporation may assist in paying premiums through a split-dollar arrangements. Other times it may be better to have the corporation own the policy and use the proceeds to purchase part or all of the owner's interest at death.
Insurance can also be purchased in certain qualified retirement plans.
In choosing the type of life insurance policy you purchase, consideration must be given to the need which is being filled: funding retirement needs, creation of an estate, payment of estate settlement costs (federal and state death taxes, last illness and burial costs, probate fees, etc.), business buy-out, key-man coverage, etc.
NOTE: Withdrawals and loans may be available from permanent policies. There are different income tax consequences if they are "modified endowment contracts"
The Problem: Deferred Estate Tax Build-Up
The Economic Recovery Tax Act of 1981 allowed postponement of estate taxes - through the Unlimited Marital Deduction - until after the death of both husband and wife. While this provides couples with increased flexibility during their lifetime, in many cases it places a substantial tax burden on the combined estate when the surviving spouse dies.
The Survivorship Life Solution
Unlike traditional life insurance, which provides protection on the life of a single insured, survivorship life covers two lives with proceeds payable at the second death. As such, it is perfectly suited to deal with the Estate Tax problem discussed above.
Advantages Over Individual Coverage
- Lower premiums - more cost effective than two
Third party ownership (adult children or an Irrevocable Life Insurance Trust) is often desirable for persons with potential estate tax problems. The policy may sometimes be transferred out the estate after the first insured dies. If the survivor lives 3 years after the gift, the full face amount should be out of his or her estate. Questions of ownership should be discussed with an attorney.
Other Uses for Survivorship Life Insurance
- Key Person Insurance - where the employer can self
insure or absorb the loss of one key individual but
Due to increasing life expectancy, preferred risk discounts, and higher returns on invested assets, some newer life insurance policies may be a better buy than older small policies.
A tax-free exchange allows one to defer the gain on any old policies at the time they are surrendered for the new policies, provided payments begin no later than under the old contract. Endowment Contracts must meet the definition of life insurance.
Life policies must be on the life of the same person.
Annuity contracts must be payable to the same person(s).
When contracts are assignable, there should be a direct transfer of funds between insurance companies. Note There are some exceptions for troubled insurers. Rev. Proc. 92-44 and 92-44A.
The cost basis of the old policy (including certain riders and/or rating) is carried over to the new policy.
If cash or other property is part of the exchange, any gain will be recognized up to that amount.
A permanent policy with an outstanding loan can be exchanged for another similar policy with the same indebtedness.
If there is a gain, it is ordinary income.
Determine whether the incontestability period and suicide provisions are based on the issue date of the new policy or the old one.
Consider the rating of the new company.
Determine whether the old policy has favorable tax status which would not transfer to the new policy.
An experienced life agent is an important guide through this process. Make certain you are medically insurable before the old policy is terminated and that there is not a period between the exchange when you have no coverage.
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