The In-Force Life Insurance Illustration – Why It’s Important

This is one of the most important tools to help you determine if your “permanent” life insurance policy is, in fact, permanent. When you first bought your permanent life insurance policy, which could be Universal Life, Variable Life or Whole Life Insurance, you were given a life insurance “illustration.” Your illustration, among other things, projects how long your policy is going to last. While your life insurance illustration must meet certain regulatory requirements, it also is limited by the linear nature of the returns it projects for your policy. In layman’s terms, neither the carrier or anyone else has any way of knowing what the returns are going to be on your premiums dollars. Therefore, it projects whatever it’s making now (called the “Current Rate”) out to infinity. This has obvious flaws. The bottom line is that, unless you have a No-Lapse Guarantee life insurance policy, no one can know if your policy is going to be around when your family needs it.

The best way to determine how your policy is doing is to run an “in-force” life insurance illustration. If you have a Variable Universal Life Insurance policy, make sure your agent runs the illustration at a low rate of return, say, at 4%. This will prevent him or her from manipulating the results. For any other type of policy, your in-force illustration will be run at the Current Rate.

For best results, have one run every year or two. That way, you’ll keep on top of it and will be less likely to get a nasty surprise in the form of a “Lapse Notice.” For more info, please go to:

Business Continuation for More Than Two Owners – Second in a Series

In the previous article, I cited that an “Entity Purchase,” one in which, essentially, the business buys out the deceased shareholder’s beneficiary, presumably the spouse.  While this arrangement may seem logical, it is the least efficient from a tax-perspective.  This is because the remaining shareholders do not get a “stepped-up” tax basis on the newly acquired shares and wind up paying the maximum in capital gains taxes once they sell their share of the business.  What should they do?  Can they conveniently reduce their tax burden?  Some intrepid life insurance agents have suggested that the owners purchase multiple life insurance policies:  the formula for this is (the number of business owners – 1) x the number of business owners).  So, if there are three business owners, they should purchase a total of six policies ((3 – 1) x3)).  Here’s a better way that accomplishes the following:

1.  Simplicity.  Three business owners;  three life insurance policies.

2.  Stepped-Up Tax Basis.  Your capital gains taxes are minimized.

The solution is for a trust to be both owner and beneficiary of all the policies.  This way, when one of the business owners passes away, the trust receives the proceeds and buys out the deceased shareholder’s beneficiary.  Because of the trust arrangement, the remaining shareholders receive a stepped-up tax basis, and their capital gains taxes are held to a minimum.  A word of caution:  make sure that you get an attorney who has written these kinds of  trusts before.  You’ll save yourself a great deal of trouble by doing a bit of research first!

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Taxation and Your Life Insurance Policy

Question:  when are the proceeds from your life insurance policy taxable?  Answer: when you own your policy!  Okay, that was a bit of a trick question.  Life insurance proceeds are generally federal income tax free and, more often than not, are subject to federal estate taxes.  Today, we’re going to focus on avoiding federal estate taxes with your life insurance policy.

If you keep in mind one simple rule, you’ll go a long way to understanding why certain property is subject to federal estate taxes.  That is rule is that everything you own or control is subject to federal estate tax.  When considering life insurance, this means that, even though the proceeds from your life insurance policy go to your children, for example, those proceeds are included in your estate simply because your owned the life insurance policy!  Federal estate taxation is driven by ownership.  The good news is that the federal estate tax threshold is over $5 million; the bad news is that your life insurance policy can get you there pretty quickly.

So, what to do about it?  Fortunately, the answer is pretty easy:  in order to remove your life insurance policy from your estate, transfer the ownership, i.e., gift, your policy to a third party such as your child(ren).  Be aware that the “Three-Year Rule” applies and states that, if the transfer-or dies within three years of the transfer, the full amount of the proceeds is included in his or her estate as if the transfer was never made.

However, the execution of the above is a bit more complicated. When transferring the ownership of a life insurance policy, consider the following:

  • The new owners must pay the life insurance premiums.  You can gift the premiums to him or her and the recipient can then pay the premium.
  • You forfeit all rights to make any changes to the policy.  Remember: this is an irrevocable gift, and, as such, you lose all control over this property.

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Common Estate Planning Mistakes – Second in a Series

As you’ve seen in previous discussions, Estate Planning can be very complicated and is not something that should be undertaken blindly. So, with that in mind, here are a few more common estate planning mistakes that can be easily avoided:

1. Improperly owned life insurance. Whenever life insurance proceeds are paid to the insured’s estate, these proceeds add to the value of the insured’s estate thereby compounding all sorts of problems. These include increased probate costs; in many states, increased inheritance taxes; and, quite possibly, increased federal estate taxes. All these problems could easily be avoided with a properly structured life insurance policy, i.e., one which is owned outside the estate.

2. When a husband is required by divorce decree to purchase a life insurance policy on his life, he receives no tax deduction for the premiums paid if he owns the policy. The best way to avoid this and to ensure a tax-deduction is for him to increase his tax-deductible alimony payments and to have his ex-wife purchase – and own – the policy on his life.

3. Lack of Liquidity. Most people don’t have the slightest idea of how much it will cost to settle their estate or, worse, how quickly taxes and other expenses need to be paid. Worse still is the “fire sale” of illiquid assets such as real estate or the family business resulting from an insufficiency of cash.

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When to Take Social Security Retirement Benefits

Generally speaking, Social Security benefits make up one-third of a retiree’s income.  Therefore, the decision about when to begin these benefits is a vital one and will have a crucial impact on your quality of life during retirement.
What is “full retirement”?  Full retirement used to mean age 65.  That is still the case if you were born prior to 1938.  However, if you were born in 1938 or later, “full retirement age” gradually increases to age 67.  It all depends on the year in which you were born, and you’ll have to go to the Social Security website ( to be certain.
Early Retirement equals Reduced Benefits.  Age 62 is generally the youngest age at which you can receive Social Security benefits.  Depending on your birth-year, your benefits will be reduced accordingly.  For example, if your full retirement age is 65 and you take Social Security at age 62, your benefits will be reduced to 80% of what they would have been if you had waited until age 65.  Note: you may encounter the term “Primary Insurance Amount (PIA),” which is simply your full Social Security Benefit at your normal retirement age.  In our example, at 62 year old retiree with a full retirement age of 65 will receive 80% of his or her PIA.
Delayed Retirement equals Increased Benefits.  What happens if you delay retirement past your normal retirement age?  You get paid for waiting!  You receive a progressively higher benefit for each year you wait up to the age of 70.  The amount of the increase will vary and depends on your year of birth.  For example, if you were born in 1943 or later, your PIA will increase by 8% per year for each year you wait beyond your normal retirement age up to age 70.
Which is Better:  Earlier or Later?  Great question.  This depends on a number of factors such as longevity in your family.  Obviously, if your parents passed away in their sixties, you might want to take your Social Security the minute you turn 62.  Also, you’ll want to consider what the rest of your cash flow will look like in retirement.  Will you have other guaranteed income sources such as annuities or pensions?  Put together a simple “Cash In / Cash Out” spreadsheet, and be as specific as possible with your income sources.  Add 20% to the “Cash Out” column.
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Long-Term Care: Partnership Programs

In a Long-Term Care (LTC) Partnership program, a state government and private health insurers work together to make available to residents of that state LTC policies that are “linked” to Medicaid. If a buyer of a Partnership LTC policy later faces long-term care needs that exceed the policy’s limits, he or she may apply for assistance from the state’s Medicaid program under more relaxed eligibility rules. This means that the policyholder may keep larger amounts of assets than would normally be allowed under the standard Medicaid guidelines. Please note that these relaxed eligibility rules only apply to assets that may be retained – all other standard Medicaid qualification guidelines apply.

For example, Michelle, a single woman, purchases a partnership LTC policy, which has a total benefit of $100,000. She later uses the full benefit of $100,000. She then applies for, and is eligible for, Medicaid. Because she had first received benefits through a partnership LTC policy, she is allowed to retain $102,000 in assets and her state will not seek to recover that amount after her death. Otherwise, she would have had to “spend down” her assets until she only had $2,000 left.

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Common Estate Planning Mistakes – First in a Series

Estate Planning is especially complicated and, many times, mistakes can be quite costly both financially and emotionally.  I will discuss a number of common – and avoidable – estate planning mistakes over the next few posts.

Mistake #1:  Improper use of Jointly Held Property.

If excessively used or used by the wrong parties (especially by unmarried individuals), the “poor man’s will” becomes just a poor will.  For instance, double estate taxation is a distinct possibility if the joint ownership is between individuals other than spouses.  Also, in the case of a married couple, holding property jointly equates to a total loss of control at death since the surviving spouse can ignore the decedent’s wishes and dispose of the property any way the survivor chooses.  This is especially troublesome when the joint owners are in a second marriage.

Mistake #2:  Improperly Arranged Life Insurance.

Inadequate life insurance on the life of the breadwinner or on the “key-person” in a corporation can bring stinging financial hardship.  Many times, the proceeds of the policy is includable in the insured’s estate because he or she bought the policy and either never transferred the ownership to a third party (not the spouse) or remained in control (called “an incidence of control”) of the policy in some manner.

Mistake #3:  The Unholy Triangle.  This is really an offshoot of #2 but it deserves it’s own paragraph.  This occurs when three separate entities / people are party to a life insurance contract.  For example, if the wife is the owner of a life insurance policy on the husband (the insured) and the children are made the beneficiaries, then the proceeds are considered a taxable gift to the children.  We will cover more on this topic in a later post.

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