Many advisors working with affluent clients help structure financial plans to meet obvious goals, such as preserving generational wealth or ensuring a tax-efficient estate. These plans may also take into consideration more personal aspirations, like charitable giving -- and life insurance often holds a prominent place in this structure to assure certain outcomes.
As with all financial advising, however, it's important that the structure evolves as your client's needs change. Careful evaluation is necessary in the face of certain external factors, such as tax shifts or modifications to the regulatory environment. In many cases, change can be good, and the right revised plan can complement the personal wishes of your client. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (TRA 2010) may have created such an opportunity for those who are charitably inclined.
What is TRA 2010?
When President Obama signed TRA 2010, he extended the Bush-era individual tax levels and ended the near-term uncertainty related to estate and gift taxes. These extensions will expire at the end of 2012 without further action from Congress.
Within this time period, a window of opportunity exists for strategic wealth planning and transfer, particularly for high-net-worth families with the financial confidence to reduce their estate size through gifting. The lifetime gift tax exemption was increased from $1 million in 2010 to $5 million in 2011 and 2012 ($10 million during this time for married couples). This significant change could impact current estate plans and may open up additional planning opportunities.
Typically, life insurance has been used to offset anticipated estate tax burdens. With the opportunity to meaningfully reduce the taxable estate through gifting, high-net-worth families may find they own surplus life insurance.
Options for exiting surplus insurance
The easiest and most obvious exit strategy for unneeded life insurance coverage is to simply lapse or surrender the policy. Alternatively, these circumstances could also present a philanthropic opportunity.
The policy owner might consider simply naming a charity as beneficiary to the policy. The change in beneficiary can usually be handled confidentially, if desired. While there would be no current income tax advantages, the death benefit proceeds are effectively kept out of the estate through an offsetting charitable deduction equal to the benefit received by the charity. An added perk of this strategy is the continued insurance flexibility for the policy owner. Should insurance needs change over time, the policy owner retains the right to rename the beneficiary.
Gifting, by signing over both the ownership and beneficiary of the life insurance policy to the charity, will provide the entire face amount of the policy to the charity upon the death of the insured. The donor will continue to support the policy through the payment of premium. The fair value of the gift, which may require determination through a qualified appraisal, and any future premiums gifted, will be tax deductible. Should the donor discontinue premium payments, the charity may choose to continue paying premiums.
Since many charitable organizations may not have the staff to manage policy gifts or may have an immediate need for a monetary donation, a life settlement could also be an option to provide immediate funds to the charity. A life settlement is the sale of the policy rights and obligation in exchange for a lump sum in excess of the cash surrender value. Generally, the insured must be 70+ years old and the policy issued from a well-rated carrier for $500,000 or more in death benefit to qualify. The value of the policy is based upon the insured's health underwriting, the premium cost of the policy, the death benefit amount and other factors. However, since settlement proceeds are subject to taxes, in some situations it may be more advantageous to gift the policy and work directly with the charity for the subsequent settlement.
Don't miss the short window
In addition to the gifting provision of TRA 2010, other aspects of the legislation may impact an existing financial plan over the short term. Now is a very good time to review planning strategies to determine if the opportunities available over the next several months may be advantageous to your clients, and perhaps further more personal aspirations such as charitable giving.
Cynthia Poveda is vice president of Crump's Secondary Markets Solution Center. She can be reached at cynthia.poveda@crump.com. Bill Buslee, MS, CLU, ChFC, CSA, is director of advanced sales at Crump Life Insurance Services. He can be reached at bill.buslee@crump.com.
