While life insurance protection has always been an essential element of financial security for wealthier individuals and successful business owners, its value during periods of economic turmoil and personal uncertainty is unmistakable. For some clients, the substantial death benefits that life insurance offers may well become the lifeline that assures the ongoing security of their families and the survival of their businesses during times of economic and personal disruptions such as those precipitated by the Covid-19 pandemic.
Whether it is a term insurance policy purchased to fulfill the immediate protection need or a permanent insurance contract with lifetime protection and cash value benefits, life insurance represents a reasonably safe, certain, and secure financial asset in an uncertain, unpredictable world.
Focusing on client concerns today and into the future
Permanent life insurance can:
enhance the portfolios of high net worth families and
provide powerful protection from creditors
Permanent life insurance responds to four critical financial concerns
For clients who own permanent life insurance, their policy’s cash value provides additional flexibility and adaptability to respond to other critical financial concerns in uncertain times. The liquidity, tax management, and wealth transfer strategies enabled by permanent life insurance have never been more important.
Reviewing the adequacy of each client’s permanent insurance protection -- or considering the option of converting their temporary term insurance to a life-long permanent contract – provides the opportunity to recognize the immediate need for adequate protection while helping clients prepare for a dynamic environment where their needs and concerns are likely to change.
Fortunately, there are a variety of financial and estate planning strategies associated with the tax-advantaged accumulation of cash value in permanent life insurance that offer efficient, effective, and highly flexible solutions for all four of these needs in a single financial vehicle
The key is to customize the application of the policy to the situation that the client is encountering.
As a guide for working with clients in today’s challenging financial environment, we’ve mapped out the application of several of these life insurance strategies to four areas of client concern right now.
1) Preserving liquidity during market volatility and economic uncertainty
Permanent life insurance is a very liquid asset. As it accumulates and grows, the cash value in a permanent life insurance policy can become a flexible, tax-efficient source of liquidity that clients appreciate knowing they have available to:
Avoid selling investments at a loss in volatile markets
Cover unexpected expenses immediately, without borrowing or liquidating other investments
Use as collateral for loans to meet financial obligations or purchase other assets
If the policy is funded properly, clients can use their policy’s cash value as a tool for supplemental retirement income as well. Unlike any other financial vehicle, a life insurance policy automatically turns into cash at exactly the right time – when it is needed most.
On the business side, permanent life insurance remains a key part of continuity planning.
Closely-held business owners can use the death protection of one owner to finance the transition to the surviving owners through buy/sell agreements, while assuring funds are available to pay the deceased owner’s spouse.
Permanent life insurance can be used to fund non-qualified deferred compensation plans and supplemental retirement plans for executives.
A policy’s cash value also provides an accessible source of tax-free cash via policy loans when markets are volatile, the economy is in turmoil, or other traditional sources of cash and liquidity for personal or business needs are less advantageous to use. As a recent example, some business owners chose to utilize policy loans to supplement more restrictive Paycheck Protection Program (PPP) bank loans during the financial upheaval precipitated by Covid-19.
What’s more, the cost of borrowing this cash can be essentially zero if a “wash loan” is used with Universal or Variable life. With a wash loan, the crediting rate on the policy is equal to the loan rate, so the actual cost of borrowing is zero, or a “wash.”
2) Offsetting low interest rates
While the near-zero target interest rates set by central banks in the spring of 2020 to respond to the economic fallout from the global pandemic created a favorable climate for individual and business borrowers, it has made investing more challenging for those who desire to grow their assets for the future without taking on considerable risk.
For clients seeking to improve performance and reduce risk in their financial portfolios, permanent life insurance is an effective diversification strategy because the death benefit can be considered a separate asset “class” whose performance is uncorrelated with more traditional stock, bond, and short-term assets.
The inclusion of permanent life insurance as a distinct and uncorrelated asset class in the overall asset allocation can improve the performance metrics of a client’s investment portfolio.
Structured properly, life insurance is non-dilutive to the portfolio’s return. It also dramatically reduces the volatility risk and increases the Sharpe ratio or risk-adjusted return.
In addition, the internal rate of return on a guaranteed death benefit policy can be more attractive when compared with a bond fund or cash, providing a higher rate of return on a tax-free basis. The chart below illustrates how the addition of life insurance can improve the performance and reduce the risk of a diversified investment portfolio.
3) Anticipating higher income taxes
Going forward, it will be increasingly important to help clients implement strategies to diminish the impact of tax increases that are almost certain to come to pay for government spending on health, personal income, and small business support programs necessitated by the response to Covid-19.
In this climate, deploying some capital to fund specialized permanent insurance products and strategies such as Life Insurance Retirement Plans (LIRPs) may complement less liquid, more volatile investments such as private equity. A well-designed LIRP creates the opportunity to build equity and maintain a level of access to policy cash value on a favorable basis in an environment where there is considerable volatility and change. A LIRP also defers income taxes on asset growth while building substantial cash value/ equity for the future and, if structured properly, will eliminate taxes on investment returns.
4) Minimizing future wealth transfer tax increases
Going forward, it will be increasingly important to help clients implement strategies to diminish the impact of tax increases that are almost certain to come to pay for government spending on health, personal income, and small business support programs necessitated by the response to Covid-19.
Even if Washington does nothing to change other areas of tax policy going forward, the current generous estate and gift tax exemptions in excess of $23 million per couple are scheduled to “sunset” at the end of 2025. There is also some speculation that these tax exemptions could go away even more rapidly as the government seeks immediate revenues.
To be adequately prepared, clients need to start planning now for a smaller unified credit by implementing strategies that minimize the impact of federal estate taxes.
Using permanent life insurance, for example, can provide the immediate and certain liquidity needed to meet an estate’s tax liability, thus avoiding the need for the estate to sell illiquid assets at poor valuations during a market downturn, or dilute the estate assets to a level which would be unacceptable to the client. Proceeds from the policy can also replenish estate assets if the client has experienced financial difficulties in recent years.
For more sophisticated planning scenarios, permanent life insurance is an excellent tool to assure that transactions are self-completing according to the terms of a Grantor Retained Annuity Trust (GRAT) or Qualified Personal Residence Trust [QPRT].
No matter how sophisticated your clients’ liquidity, investing, tax, and estate planning strategies become, permanent life insurance is one of the most secure, enduring, flexible, and tax-efficient financial solutions that people with substantial wealth can deploy in any financial or economic environment. With the potential to provide a guaranteed death benefit, a high degree of liquidity, portfolio diversification, tax-favored asset accumulation, and tax-efficient wealth transfer, permanent life insurance can effectively address many of the most pressing financial concerns for high net worth households and businesses today and into the future.
[1] Under IRC 2042 personally owned life insurance death benefit is includable in the insured's gross estate.
This is not an offer to sell a security or insurance product. This information is provided for informational purposes only and should not be construed as legal or tax advice. You should discuss your circumstances with a financial professional before making any decisions. This material and the opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual. https://www.trcfinancial.com/disclosure