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Rightsizing Your Permanent Insurance in Retirement

Splitting the Proceeds of a 1035 Exchange Unlocks Planning Opportunities

We’ve seen strategies for utilizing accumulation-focused insurance policies that have grown significant cash value become an effective repositioning strategy. The result is an updated insurance position that reflects the client’s current needs and leverages today’s modern products.

True insurance planning is far more nuanced than finding the best underwriting offer or the best price. It involves a perspective beyond a simple needs analysis. It requires understanding how insurance needs change over time and how to best manage a policy or portfolio of policies to deliver the most effective risk management strategies to the client. Today, that means insuring against risks beyond survivor income or estate tax liquidity, with the cost of Long-Term Care as the most significant threat to a successful retirement or a source of estate erosion, reducing the legacy left to loved ones.

That statement comes as no surprise to anyone paying attention to developments on multiple fronts in our industry. That said, simply stacking a new Long-Term Care Insurance policy on top of the client’s other insurance assets may not be the answer, particularly if there are existing insurance policies that may no longer match the needs of the client. More specifically, a personally owned life policy that was a great accumulator of cash but is now under-leveraged and lacks the modern features available from today’s insurance products represents a funding source for an updated insurance strategy. The challenge is how to reposition the policy’s cash values efficiently and for maximum benefit.

Those two outcomes, efficiency and maximum benefit, can seem to be competing intentions at times. An efficient update will minimize costs, both in terms of premium outlay as well as taxation. That typically means a 1035 exchange. That immediately limits product choice to single life products on the same insured. Splitting that exchange to fund multiple policies, perhaps one focused on legacy and another on Long-Term Care, can offer superior benefits, but they remain limited to a single insured. The “Goldilocks” approach, however, still utilizes a 1035 exchange, but follows that with a second transaction. One that funds a similar strategy on the other spouse.

That second transaction, a policy loan, allows for the cash-rich source policy to fund an updated strategy for the second spouse that mirrors the one put in place for the original insured. On the surface, this would seem to create a significant risk in the form of the policy loan that could hamper long-term policy performance. That particular issue is addressed by a planned repayment of the loan via a withdrawal. The end result is two policies, one on each insured, that provide both death benefit intended for their heirs as well as a ready source of funds should the need for Long-Term Care arise.

Consider the following fact pattern:

  • A 65-year-old couple
  • The husband has permanent life insurance with $400K in surrender value
  • The wife has no permanent life insurance

The typical solution would involve a 1035 Exchange to a new policy on the husband’s life that includes Long-Term Care or Chronic Illness Benefits. The client would then fund a separate Long-Term Care strategy for the wife, paid for out of other assets. Alternatively, they could surrender the existing policy, pay any taxes due, and then fund a policy on both husband and wife.

In this case, however, a more effective solution may be available that begins with a 1035 exchange as discussed above, but rather than using other assets to fund a new policy on the wife, the existing cash surrender value on the new policy is used as the source of funds via a policy loan. Figure 1, Funding Two Policies from a Single Exchange, shows the flow of funds, including a critical component: The rapid repayment of the policy loan.

In this case, the loan repayment comes from the husband’s new policy itself. Utilizing the carrier’s ability to take a withdrawal, not to exceed cost basis, that is then used to repay the outstanding loan on the policy, effectively eliminates one of the potential downfalls of the strategy: The long-term health of the policy being compromised by a growing loan balance.

If we revisit our objective of minimizing costs and providing maximum benefits, the approach certainly meets the mark. In summary:

Existing Coverage:

  • Total Life Coverage: $700K
  • Total Living Benefits: $0
  • Lives Covered: 1
  • Account Value: $400K

Updated Coverage:

  • Total Life Coverage: $744K
  • Total Living Benefits: $349K
  • Lives Covered: 2
  • Yr 1 Account Value: $320,631
  • Yr 2 Combined Account Value: $291,228
  • Additional Outlay: $0

Admittedly, the account values are lower immediately after this transaction is executed. That said, based on current crediting rates, the combined account value exceeds $400K by policy year ten and continues to grow plus the loan balance is zero beginning in year two. In addition, there is no additional out of pocket for the client, zero taxes due, and a significant upgrade to the coverage is achieved by the addition of living benefits. In an environment where most clients are concerned on some level about the economy, finding creative ways to fund planning objectives is critical. This approach is perfectly suited to today’s economy and truly does deliver more value than a single life solution without living benefits.

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Rescuing a Bank Loan from Rising Interest Rates

With the cost of capital increasing dramatically as interest rates have risen, many commercial loans now have terms that are far less favorable, if not punitive. Fortunately, clients with life insurance assets have access to a “refinancing” strategy that can provide relief from higher rates in the near term and a long-term management plan.

With the current higher interest rate environment appearing to be more than a short-term phenomenon, clients with significant commercial loans are seeking relief from the interest burden they now bear. While shopping for a more favorable rate can certainly help, the reality is that today’s rates are so much higher than when many existing loans were originated, a slightly lower rate provides remains far in excess of the original loan terms.

Paying down these loan balances would certainly provide the interest rate relief clients are seeking, but these loans are often used to fund business expansion or other planning objectives that remain important to the client. Attempting to unwind a strategy designed to capitalize on a business opportunity to pay back a loan will often simply trade one pain for another: The pain of higher rates for the pain of missing out on the business opportunity they were pursuing. Some clients, however, may already own an asset that is perfectly suited to “refinancing” these loans at terms that are far more favorable than even the most well-qualified client can find in the market.

The asset? Cash value life insurance. In fact, this very same life insurance policy may have been the actual collateral used to secure the commercial loan in the first place. The available interest rates were far lower than those available on loans from some insurance policies. As rates have risen, however, the best use of the policy cash value may no longer be as collateral. It may be paying off the bank loan. There are two variables that have to be considered when considering the loan repayment:

Is the loan interest rate in the life policy more favorable than the bank loan? Even as bank loan rates have risen, they may remain lower than the rate available on the policy loan. The net cost of the policy loan, however, is likely to be lower based on the policy also receiving some sort of credit on the loan balance.
What’s the long-term performance impact of the policy loan? Larger loan balances can seriously impair the future performance of the policy.

For some, the answers to these questions will be favorable and a loan from the policy is a clearly superior option when compared to the terms now available from the bank. Unfortunately, that will not always be the case. Whole Life policies in particular frequently have much higher loan interest rates and large loan balances create a drag on policy performance that results in a risk of lapse in the future.

There is, fortunately, a potential remedy to the scenario described above. That remedy involves sourcing a new life insurance policy, funded by a 1035 exchange, that offers the low loan interest rate we are seeking and a strategy for maintaining long-term policy performance. In some instances, the client can extinguish the loan balance without having to pay out of pocket, leaving them out from under the bank loan they are currently struggling with and with an adequately funded policy.

To execute this strategy, there is a proper order of operations, so to speak, that needs to be followed if the life policy was, in fact, used as collateral for the bank loan. Trying to execute a 1035 exchange with the existing policy encumbered by a collateral assignment will typically not work. Instead, the following steps need to be followed:

  1. Take a loan from the existing policy first. That loan is used to bay off the bank loan, allowing the bank to release their interest in the policy.
  2. Once that is complete, a 1035 exchange to the new policy with more favorable terms can be completed.
  3. With the new policy in force, the repayment strategy begins, using annual withdrawals up to cost basis to make loan payments until either the cost basis is exhausted, or the loan is extinguished.

See Figure 1: The Bank Loan Refinancing Strategy for additional details on how this strategy plays out.

As mentioned previously, in a perfect world this loan is completely paid off without the client having to make any out-of-pocket payments. Extremely high loan-to-value ratios or a lower cost basis may not allow for a complete repayment. In those instances, the client can pay off the balance of the loan from other assets. That said, they may not have to. By minimizing the loan balance, existing policy values and projected crediting may be enough to support the policy long-term. In either case, the client’s primary objective is met: They are no longer subject to today’s higher rates on their outstanding bank loan.

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Indexed UL with an Exit Strategy

Varying economic conditions cause permanent life insurance products to fall in and out of favor. That’s not much of a problem for new insurance policies, but for in force policies it presents a major issue: Actual performance that does not meet expectations set at the time of sale. When that happens, a policy owner may not have great choices as they see to make the best of a bad situation. Unless, of course, their policy was purchased with just this possibility in mind.

Dealing with actual performance that does not meet the sales illustration or client expectations is all too familiar to those who have sold many types of life insurance. Declining dividend rates in Whole Life (WL). Market performance that didn’t materialize in Variable Universal Life (VUL). Index Cap and Participation rates that were unsustainable in Indexed UL (IUL). That doesn’t make any of these products inherently inferior or inappropriate. It does, however, point out that they can lack the flexibility needed to manage varying economic conditions. The exception? It may be Variable Life, but with a twist.

The rise of downside protected insurance products that also offer market-based returns has resonated with many consumers for easily understandable reasons. Primary among them is loss aversion. Once that is in place, however, the other side of the coin in the form of performance enters the conversation. In the case of IUL, actual performance can be severely limited by both the Cap and Participation rates, particularly as a segment matures and is subject to a renewal Cap or Participation rate. This is where performance can start to lag, and policy owners start to look for alternatives. Typically, that means either stay the course, or pivot to a new vehicle. Even if they are insurable and outside the surrender period, they are likely to be hesitant to commit to a similar strategy with a new product that is more well suited to the current economic environment.

A more graceful solution would avoid the need for underwriting and surrender charge considerations if it were already present in the very policy the client already owns.

Fortunately, that product exists. Numerous offerings in the VUL segment include “indexed subaccounts” based on the very downside protected indexing strategies found in IUL. In addition, buffered strategies that have become widely available in the Variable Annuity market have now made their way into the VUL market, offering a different balance of downside protection and upside potential than an IUL or indexed subaccount. Clients who own a VUL with these strategies are in an enviable position: Their solution to falling Cap rates, as an example, is built into the product they own.

If Cap rates, as an example, fall to the point that the upside potential of the strategy is no longer acceptable to the policy owner, they can simply change their allocation to a more suitable or attractive alternative from the menu of subaccounts available in their product. While it is tempting to think about this only in the context of wanting more upside potential, it could very well be predictability that the client is seeking in some instances. In that case, perhaps an allocation to the fixed account makes the most sense. Perhaps a bond fund allocation? Further, this is not an “all or nothing” decision and allocating a portion of their cash values across multiple subaccounts, each with its own unique risk/reward profile, may be the most appropriate course of action.

See Figure 1, below, for additional details on the difference between an IUL and VUL in these circumstances.

Figure 1: Strategies for a Falling Cap Rate


The point? There is never an empirically superior product type. The one that happens to be in favor today may very well be out of favor or perhaps significantly impacted by changing economic conditions within a few years. Rather than try to “time” the insurance market, perhaps it’s time to simply use a more flexible strategy that gives the clients a way to pivot when conditions change?

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A Buy-Sell Arrangement that Benefits the Living and the Dead

It’s a fact: Most business owners will execute a living buyout rather than have a business owner die prematurely. That singular fact makes it critical to have a buy/sell agreement in place that can provide protection from a premature death while simultaneously position the business owner for their eventual retirement.

In one of our industry’s more delicious ironies, the type life insurance typically used to fund Buy/Sell Agreements (BSAs), term insurance, is probably the least appropriate funding solution. The truth of the matter is that a permanent solution, with properly structured ownership, places a powerful financial planning tool in the hands of each business owner. A permanent life insurance solution can not only fund their BSA, but also provide supplemental, tax-favored retirement income, long-term care benefits and more.

The reasons for this trend can obviously be attributed to price in some instances, but there are other factors at play. A significant one is the perceived lack of control in most cases stemming from either another owner or the business itself controlling the policy. In most instances this can be traced back to a knowledge gap relative to the types of agreements beyond those two basis structures. Fortunately, in this particular instance, the solution not only addresses the fundamental issue outlined above, but it does so without having to increase the complexity of the agreement to the point it becomes unwieldy, if not prohibitive to administer.

If step one in this process of designing a more effective BSA is simply moving from term insurance to permanent, the next step is addressing ownership. In too many cases, the simplicity and ease of implementation that comes with a stock redemption plan, with the business owing the policies, receiving any death proceeds, and “redeeming” the shares of the deceased owner is too tempting. This not only eliminates the possibility of significant tax savings for the surviving owner, a topic for another discussion, but stilll places the business owner at a disadvantage relative to controlling all of their insurance assets as the company remains the owner and beneficiary of the surviving owner’s policy. Traditional cross purchase designs, while more advantageous from a tax perspective, still present the issue of lack of control: The other owner owns the insurance! While these two approaches can accomplish the ultimate goal of providing funding for the BSA when it is needed, it is far from an optimized solution.

That leaves the obvious question: If both of these types of BSA are less than ideal, what’s the answer? While each planning scenario is different and should be evaluated on its own merit, the “Cross Endorsement” structure checks man of the boxes discussed here:

Each business owner is the owner of the policy on their own life.
As a result, they control the death benefit, cash values and any living benefits the policy may provide.
A simple assignment form the secures the portion of the death proceeds needed to buy out the other business owner at their death.
More importantly, this also allows each owner to make full use of the policy as part of their retirement, long-term care and perhaps even estate planning if they, like most business owners, execute a living buyout.
Finally, at retirement this all happens without some sort of taxable event or an esoteric exemption to the transfer for value rules most do not understand, let alone plan for effectively.

Figure 1, below, shows the basic mechanics of this approach in terms of the flow of funds if one of the owners pass away. What it doesn’t do, is address how each owner can make the “highest and best use” of their policy. To do that, it is critical to move the owner beyond viewing this premium associated with their BSA funding strategy as an expense to something that creates an asset on their personal balance sheet. That effectively eliminates term insurance from the conversation.



The key subject matter areas to discuss with the owner as they consider how to structure their funding strategy with permanent insurance include:

  • Their protection needs beyond the BSA. Specifically, is their personal insurance adequate? If not, simply increase the amount of coverage on the policy to an amount that covers both the business and personal need.
  • Have the planned for the potential need for care as they age? If not, consider the use of a Chronic Illness or Long-Term Care Rider on the policy.
  • Is their retirement plan adequately funded? If not, consider a policy designed to accumulate cash value while also providing a death benefit. This could also solve challenges like limitations on qualified plan contributions.

The beauty here is in the flexibility. Each owner can design their own strategy based on their needs. Once in force, simply filing the assignment secures the other owner’s interest in the death benefit in an amount equal to their obligation under the BSA.

As simple as this strategy is, there are some places where Business Owners may try to cut corners. Specifically, this arrangement does not eliminate the need for a formal, written BSA. Further, the BSA needs to be reviewed regularly, including updating the value of the business. If they want to pay for the coverage through the business, as most Business Owners do, there will likely be personal income taxes due on those funds, likely treated as compensation. There may also be tax due on the economic value of the assigned coverage. Both of these issues make the Business Owner’s CPA or other tax expert a critical part of the conversation.

There are additional benefits to the Cross Endorsement or “Living Benefits” Buy Sell Agreement, including:

  • Personal ownership of your policy — The Business Owner names the primary beneficiary and controls the cash value. Any death benefit not committed to the buy-sell agreement can go to family or other personal beneficiaries.
  • Younger and healthier owners aren’t required to pay premiums on older and less healthy business partners as they might be with a cross purchase buy-sell agreement.
  • You can fund your own policy at a higher level to build greater cash value for your future use.
  • Policy is portable — if the business ends or you retire, you still retain the policy and any cash value.
  • As an individually owned policy, it may be protected against business creditors depending upon the laws of your state.

The bottom line? There is far more utility from a Cross Endorsement BSA funded with permanent insurance than is available from other agreement types or agreements funded with term insurance. We would all benefit from taking a moment to consider the rest of the Business Owners planning versus pursuing the path of least resistance.

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The Long-Term Care and Estate Tax Legislation Hedge

There’s a lot of potential change on the horizon in the Long-Term Care and Estate Planning markets. Between a potential wave of state level LTC legislation plus the possible sunset of the estate tax exclusion levels embedded in the Tax Cuts and Jobs Act (TCJA), clients are facing a period of uncertainty than can have real consequences over the balance of the decade and beyond.

As important as both of those potential planning challenges are, the largest risk clients are facing is the very real need to have a plan for care in place as they age that includes both how they want to receive care as well as how to pay for it. Many are feeling this rather acutely as they care for their own aging parents.

For clients who may find themselves subject to estate tax if current estate tax exclusion limits expire, their Long-Term Care strategy needs to be flexible enough to not only position them to take advantage of any possible opt-out of state level LTC programs, but also address the potential TCJA sunset. It likely also involves pushing some of this risk off to the experts: Insurance companies. A well-conceived and executed solution will:

  • Use the most cost-effective strategy to secure Long-Term Care coverage
  • Allow for “ownership optimization” of the coverage in the event of the TCJA sunset that creates an estate tax liability

The primary objective is to provide robust LTC benefits as efficiently as possible. Assuming the client has beneficiaries, a life insurance solution likely offers the best value, with either the client or their loved ones receiving significant benefits. At the same time, the use of a joint life product that accumulates cash provides additional efficiency and flexibility.

  • Fund a Survivorship IUL (SIUL) policy with LTC rider:
    • Covers both insureds with an individual pool of LTC
    • Provides Indemnity benefits
    • Offers a potential return on premiums instead of simply return of premium
    • Establishes or enhances a significant legacy if not needed for care
  • When/If the client has future estate tax exposure:
    • Transfer ownership of the coverage to the client’s newly established ILIT. This reduces their taxable estate once the look-back period expires
    • Utilize trust language that allows access to LTC benefits during their lifetime. If there is a claim, this could remove additional assets from the client’s estate

For a pair of 55-year-olds, both in Preferred health, a properly-funded $1MM SIUL policy with a total LTC pool of $500K each has an annual premium of $10,890, well within the annual exclusion gift limit. If none of the risks we are seeking to hedge actually come to pass, their beneficiaries receive the proceeds. The tax-equivalent IRR on the proceeds assuming the clients pass at age 90 is 6.06%.*

The other question is what happens if they need care? If both clients exhaust their benefits during their lifetime, the IRR may increase given they would likely receive these benefits earlier in life.

How does the Hedge Play out?

Potential LTC Legislation

In the event the client’s state of residence enacts LTC legislation with an opt-out provision triggered by existing LTC coverage ownership, the clients may be eligible based on the true 7702B LTC benefits included in the policy. While the specifics of any future legislation are obviously unknown, it is possible that Chronic Illness Benefits under section 101(g) may not qualify for opt-out, making 7702B products a safe harbor of sorts.

Additionally, given that the final form of any legislation is yet to be specified, the ability to opt out and the requirements to do so are unknown at this time. This makes it critical to focus on the planning need first, with the goal of opting out of any future legislation as a possibility rather than the sole driver of the purchase of LTC coverage. A review of any proposed legislation in the client’s state of residence as part of the planning process is essential.

Potential Sunset of the Tax Cuts and Jobs Act

The only thing we know about the future of estate taxation, based on history, is that there will be change. In the event the client finds themselves with an unexpected estate tax exposure resulting from future changes, establishing an ILIT and subsequently transferring ownership of the policy to the ILIT removes the death benefit from their taxable estate after the look back period expires. The use of indemnity benefits on the Nationwide policy also unlocks an extremely estate tax friendly way to manage the benefits, that can remove additional assets equivalent to the benefits received plus interest from the client’s taxable estate. Please see Figure 1, below for additional details on this element of the strategy.



Unlocking the “Extra” Estate Tax Exclusion

Client Needs Long-Term Care

  • Client buys $1MM life policy with LTC rider in their ILIT using funds earmarked for LTC
  • Carrier pays indemnity LTC benefit to the trust ($20K/month for 50 months)
  • Client borrows funds from trust to pay for LTC expenses
  • Interest is capitalized annually
  • The client passes away at exhaustion of benefits
  • LTC Benefits Paid: $1,000,000
  • Accrued Interest: $220,000
  • Estate Debt to Trust: $1,220,000

At Client’s Death

  • Estate Repays the Loan
  • Total Amount in Trust: $1,220,000

Additional Details

  • Trust Language must allow for LTC ownership as well as loans to the Grantor.
  • Not all Insurance Companies allow their LTC products to be owned in an ILIT.
  • There are very specific technical requirements for the loan to the Grantor.


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Solving the Challenge of a Stretch IRA

While the recently passed SECURE Act 2.0 is generating quite a bit of conversation in retirement planning circles, it has not had near the impact in the life insurance segment that the original SECURE Act did when it was passed back in late 2019. The primary impact of SECURE 1.0 in the life insurance space was the significant change to Stretch IRA rules, making inherited IRAs even more of a tax challenge for beneficiaries. Read on to learn more about a strategy to work with both G1 and G2 for a comprehensive solution!

In an ironic twist, planning opportunities stemming from SECURE 1.0 focus not as much on the taxes paid by beneficiaries, but on the “G1” IRA owner who has had the good fortune to accumulate a large qualified plan balance and the ability to fund a traditional IRA Maximization strategy involving current distributions to fund a life insurance policy with far more favorable tax treatment. This presents some planning obstacles for all involved, including:

G1 IRA owners who may not be concerned about the tax implications for their beneficiaries, believing that they are “getting enough” simply by inheriting any assets not consumed during G1’s lifetime net of any taxes.

Even if G1 does care about the tax issue, they may not be insurable, eliminating the viability of the strategy entirely.

For those clients that execute traditional IRA Maximization, there will almost certainly be a remaining qualified plan balance that will be heavily taxed upon passing to G2.

This last issue, the remaining balance inherited by G2, has two components:

Income taxes due on the inherited amount over the ten-year period mandated by SECURE 1.0.

Taxation of any gains on the net proceeds that are then invested.

Fortunately, many of the challenges listed above are easily solved with a life insurance strategy focused on G2. By establishing a permanent life insurance policy as part of G2’s retirement planning approach, there is the possibility of avoiding the taxes that would be due on gains from other asset types. This policy is funded by a portion of the inheritance, and are a number of design elements to consider to render it maximally effective:

Consider using a face amount in excess of the minimum required to accommodate the portion of the inheritance allocated to the strategy.

The “balanced” approach to the design will also increase any amounts available via accelerated benefit provisions included in the base policy or added via rider, strengthening G2’s care planning strategy.

Availability of participating loans early in the policy could allow for higher funding levels, subsequently using a policy loan to pay taxes when due in April of the following year, versus holding a portion of the proceeds back in anticipation of future taxation.

Another consideration is one of timing. While the fact that there is a future inheritance may be known fairly early on, the timing of the event is obviously unknown. This could present a problem if there are insurability issues for G2 that present themselves at the time of the inheritance. The solution to this challenge is to put the insurance in force on G2 early in the process, in anticipation of the future inheritance. Doing so eliminates insurability as a future unknown and would also become part of G2’s overall retirement planning. Having a tax-favored source of retirement income above and beyond the ability to accommodate the inheritance strengthen the resilience of their overall retirement plan. If this approach is pursued, the use of a policy face amount higher than the minimum required for G2’s premium budget at inception creates the capacity to accommodate the future inheritance.

While this strategy has been described as a way to solve the issue of not being able to execute a traditional IRA Maximization strategy, the use of these two strategies in concert would be maximally effective in terms of reducing taxation of the IRA and minimizing G2’s tax burden on a forward-looking basis. This “second sale” to G2 in an IRA Maximization strategy can also be used to prospect up or down the family tree, depending on where the original client relationship lies.

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Succession Solutions for Single Owner Businesses

The lack of a second business owner does not eliminate the need for effective buy/sell planning. A well thought out, formal agreement with proper funding can still accomplish the owner’s goals for the business upon their retirement, disability or death.

A place where that can break down is the buy/sell agreement. We’ve all heard the stories of businesses without a plan in place, and one of the frequent causes is the lack of a clear successor. That, like so many other things in our business, can be overcome with the right planning. The most effective approaches address both the planned and the unexpected triggering events and can employ the leverage of life insurance to create or augment a funding strategy.

Consider the business owner whose business is their primary asset and is without a clear successor.

Most would likely think about finding an outside buyer. If all goes to plan, that can absolutely work, but the unplanned exit remains a challenge. The “No Sell Buy/Sell” strategy can be part of a solution to this challenge and uses many of the traditional elements of a buy/sell agreement, with one significant exception: The business owner controls both sides of the transaction. More specifically, a trust they establish, and control becomes the buyer of the business, funded by life insurance proceeds.

This No Sell Buy/Sell involves some of the fundamentals seen in a traditional buy/sell agreement between two owners:

  • Establishing a fair value for the business
  • Funding the plan with a life insurance policy

It also serves as a way to buy the surviving family members time. The family can still control the business through their control of the trust. If, the business is ultimately sold to an outside party, it will be at a time and at terms of their choosing. The infusion of cash from the initial sale of the business to the trust provides the liquidity they need to be patient if that is what is best for the family. Further, if the business is ultimately sold to an outsider for less than the family hoped, those life insurance proceeds serve to make them whole relative to their prior valuation of the business. Depending on the client’s other planning objectives, this strategy can also integrate with their retirement and estate planning. Please see Figure 1, The No Sell Buy/Sell Strategy for an overview of the approach.

Of course, in some cases, there is a Key Employee who would love to take over the business, but they may not see a way to make it happen. This is where effective planning can again overcome a rather common obstacle.

In this situation, there is an opportunity to take a more traditional approach, complicated only by the fact there is not a second owner of the business also seeking to implement a buy/sell agreement. Instead, the designated Key Employee plays the part of the second owner. The key difference is that the Key Employee does not have an ownership position in the company, making this a “one way” buy/sell agreement. Aside from that difference, the mechanics are much the same as they would be in a traditional buy/sell agreement between two owners.

The Key Employee purchases a life insurance policy on the owner of the business. They Key Employee is the policy owner, is responsible for the premium payments and is also the policy beneficiary. At the death of the owner, the life insurance proceeds are used to purchase the business from the owner’s estate per the terms of the buy/sell agreement. If appropriate, the policy can also play a role in a living buyout and may even be funded by the business via deducible bonus payments to the Key Employee. Please see Figure 2, The One Way Buy/Sell Strategy, for an overview of the mechanics.

The approach above, admittedly, relies heavily on life insurance as the primary finding vehicle. The business owner may benefit from an approach that also more directly addresses a living buyout as we see in the Sole Owner Transition Plan. This strategy includes the sale of a small portion of the business at plan inception, and utilizes installments notes and life insurance to protect both the owner and acquiring Key Employee.

Once the Key Employee completes the initial purchase of a small portion of the business, a traditional buy/sell agreement is put in place that serves all the same functions as it would in a multi-owner business. One of the most important elements is the use of life insurance to protect the original business owner in the event the Key Employee passes away or decides to leave the business. The balance of the sale occurs at the typical triggering events, and can be funded via life insurance, installment notes, or a combination of the two. See Figure 3, The Sole-Owner Transition Plan, for additional details.

Regardless of which of the three approaches outlined here is ultimately implemented, the underlying message remains the same: The lack of a second business owner does not eliminate the need for effective buy/sell planning. Further, the owner may have more flexibility in these cases simply based on their control of the decision-making process. Whether they ultimately involve a Key Employee as the buyer or a trust via the No Sell Buy/Sell, the outcome is the same: A well thought out, formal agreement with proper funding that accomplishes their goals for the business upon their retirement, disability or death.

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Solving the Executive Benefits Gap

In the business market, top performers often command a more robust suite of benefits than the rest of the company. Unfortunately for some, that is not always the case. In fact, on a percentage basis, the top performers often lag the rest of the company in three fundamental areas. Fortunately, this “Benefits Gap” can be solved, either within the benefits plan itself or with individual solutions. Read on for the details!

Where’s the Gap?

The Benefits Gap shows up in three areas most frequently:

  • Retirement Planning
  • Disability Income Protection
  • Life Insurance Protection

Even if the client “already has” these benefits in place at their employer, a quick look at the benefits relative to the client’s income surfaces a significant shortfall. Also important: If the client is relying solely on employer sponsored plans that are NOT portable, personally owned insurance is the only way to address this issue without leaving the client exposed should they change jobs.

How to Close the Retirement Gap?

Closing the gap ultimately comes down to having a supplemental retirement plan. In the employee benefits setting, that can be accomplished via a deferred compensation plan or other bonus plan. Absent an employer that is willing to contribute additional funding, it’s up to the individual to make up the difference. In that case, evaluating the client’s “asset location” or the tax efficiency of their overall retirement plan, often points to the need for a larger allocation to assets that, when properly structured, are not subject to ordinary income or capital gains tax. An increase in that allocation can not only close the retirement gap, but also provide the critical tax diversification that allows clients to respond appropriately to future changes in tax rates in retirement.

Figure 1: The Retirement Gap

How to Close the Disability Gap?

It really all comes down to having a supplemental disability insurance plan that integrates with the client’s group coverage. In the employee benefits setting, that can be accomplished via an executive carve out that offers additional, personally owned and portable disability insurance protection to the executives in the organization. Absent an employer that is willing to implement a plan, it’s up to the individual to make up the difference. In that case, leveraging today’s modern application and underwriting processes can allow for implementation of significant amounts of coverage with minimum interruption of the client’s busy schedule.

Figure 2: The Disability Gap

How to Close the Life Insurance Gap?

Having a supplemental life insurance plan is ultimately how to close the gap. In the employee benefits setting, that can be accomplished via an executive carve out that offers additional, personally owned and portable life insurance protection to the executives in the organization. Absent an employer that is willing to implement a plan, it’s up to the individual to make up the difference. In that case, leveraging today’s modern application and underwriting processes can allow for implementation of significant amounts of life insurance with minimum interruption of the client’s busy schedule.

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Making the Case for Annuity-Based Asset-Based LTC Products

It’s tempting to use an “apples to apples” approach when considering the premium deposit used to fund an Asset-Based LTC solution. Given the availability of a tax-free 1035 exchange when an annuity is the source of funds, it’s critical to take any tax taxes due on the surrender of the annuity into account when determining the amount available to fund the strategy.

We all know how important it is to keep things simple for clients. Covering the essential components of a planning strategy as efficiently as possible increases understanding and improves the quality of their decisions.

In the Asset-based Long-Term Care (ABLTC) segment, however, there is a detail that must be considered that is often overlooked: Source of funds. Specifically, clients need to understand the pros and cons of using non-qualified funds versus qualified funds, annuities versus brokerage accounts and the like when funding their care planning strategy.

This becomes even more important when we consider the tax ramifications specific to each funding source, particularly when considering non-qualified annuities. Why call out non-qualified annuities specifically? Simple: There’s an opportunity to avoid a taxable event altogether by selling an annuity-based ABLTC product. The availability of a tax-free 1035 exchange into an annuity-based ABLTC product unlocks the power of the Pension Protection Act and changes the true cost of the care planning strategy.

These cases can play out in a couple different ways. The most common is a “Money Purchase” approach that starts with the existing annuity’s cash value. That amount is used as the single premium to purchase an ABLTC solution. The tax issue is often overlooked and has a material impact on the decision-making process. More specifically, the single premium used to fund a life-based ABLTC product should be discounted by the taxes due on the liquidation of the annuity. That net amount is then used as the single premium on a life-based solution, while the full amount can be used to fund an annuity-based product. Please see Table 1 for an example.


Table 1: Impact of Taxes on Non-Qualified Annuities


¹ Tax Rate Assumptions: 24% Federal, 10% State, for a combined 34%

Table 1 shows the significant difference in the net premium available to fund a care planning strategy with funds from a non-qualified annuity based on the type of ABLTC product being considered. While the full amount is available to an annuity-based product. the lower amount net of taxes is what is truly available to fund a life-based care planning strategy.

The resulting impact of an increased premium on available LTC benefits is obvious: With more funds deposited into the annuity product, the corresponding benefits may be richer. Does this mean that an annuity-based product is always going to outperform a life-based product? Absolutely not. It will increase the frequency of the annuity-based solution delivering superior benefits, however.

The fundamental question that needs to be answered is if the increased funding into the annuity-based solution is offset by the superior leverage typically found in life-based products? In this case, with a 35% combined tax rate assumption, the life-based product would have to deliver a 20.48% greater monthly benefit per dollar of premium for the total monthly benefit to equal the benefits available from an annuity-based solution This is demonstrated by the following calculation:

  • Life-Based Premium: $166,000
  • Annuity-Based Premium: $200,000
  • Shortfall: $34,000
  • Shortfall as % of Life-Based Premium: $34,000/$166,000 = 20.48%

Consider a sample case, with the following case design parameters:

Male, age 70

  • Couples Discount
  • 6-year Benefit Period
  • 3% COLA
  • Maximum Monthly Benefit

Revisiting the cash flows from Table 1, above, now including the corresponding monthly benefit amounts, shows not only the superior outcome of the annuity-based solution for this case, but also how it could have been “hidden” if the reduced, after-tax deposit amount was not used. Please see Table 2 for additional details:


Table 2: Impact of Taxes on LTC Benefits


¹ Tax Rate Assumptions: 24% Federal, 10% State, for a combined 34%

Table 2 shows how case design is impacted by the source of funds. Not taking the taxes due on the surrender of the annuity into account could easily lead to a sub-optimal recommendation. At first glance, it appears that the life-base solution is superior. However, that design has a hidden cost of an additional more than $34,000 in taxes as seen in the column titled Life-Based ABLTC, Taxes Considered.

This effectively reduces the amount available to fund the life-based strategy. A review of the additional two columns showing the impact of taxation point to the annuity as the superior solution in terms of monthly benefit. In this case, a monthly benefit at age 80 that is $1,032 or 11.15% higher in an annuity-based solution.

Other Considerations

While the primary metric in a care planning case is usually the monthly benefit amount, there are other factors at play. The death benefit that may pass to beneficiaries if not accelerated for care is likely the most significant. Not only are death benefits from the life-based products typically larger, but they are also tax-free to the beneficiaries. Liquidity is typically superior in an annuity-based versus life-based product. These factors will need to be considered as part of the decision-making process.

Another important point to consider is the use of a COLA Rider. Annuity-based products like the one used in this example may perform better without a COLA Rider. The current crediting rate of the annuity, if used to project future benefits, can result in a greater monthly benefit. That amount, of course, is not guaranteed, while the benefits available from the COLA Rider are contractually guaranteed. Given the nature of the sale, the guaranteed benefits are likely more appropriate as well as being directly comparable to those from a life-based solution.

All of the above as well as the ultimate outcome is dependent not only on the use of the appropriate premium amounts, but also the age of the client, use of a COLA Rider and the like. None of that however changes the bottom line need to use the annuity value net of applicable taxes when running proposals.

A potential complication is the annuity with a surrender value in excess of the premium needed to fund the strategy. Fortunately, most annuity carriers, including those that offer annuity-based ABLTC products, also offer other annuity products and may be able to execute a “split 1035 exchange” upon receipt of the funds. This would allow a portion of the exchanged funds to be allocated to the annuity-based ABLTC product with the balance being deposited into a different annuity product from the same carrier. While more complicated, the surrendering company may be able to facilitate a split exchange involving two different receiving companies, creating additional flexibility for clients in this situation.

Underwriting comes into play as well. Annuity-based ABLTC products may offer a simplified underwriting process that is also more accommodating of some health conditions.

Next Steps

Fortunately, taking the impact of taxes into account in these scenarios involves only two additional pieces of data and a bit of math: When working with non-qualified annuities, always calculate the net premium amount using the cost basis and an income tax rate assumption when not utilizing a 1035 Exchange. Use the resulting net proceeds available to fund a life-based product and run proposals for both life-based and annuity-based products accordingly. The results may surprise you!

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A Fresh Approach to an Executive Benefits Strategy

If you’ve worked in the business market, you are undoubtedly familiar with Section 162 Bonus Plans. Rather than the traditional life insurance focused approach, this fresh approach delivers something that may be perceived as even more valuable: Long-Term Care coverage.

Life insurance has long been used as an Executive Benefit, with myriad strategies for structuring agreements that can further corporate objectives around employee recruitment and retention. Despite the high usage rate of life insurance products, this use case has not carried over into the Asset-Based Long-Term Care (ABLTC) product segment. Given the forces in play that shine a light on the need for more effective care planning strategies and funding solutions, the benefits offered by an ABLTC solution may be more valuable than life insurance in the eyes of key employees.

The combination of personal experience with their loved ones needing care, the increasing cost of care and the rising tide of state level legislation focused on Long-Term Care has created an environment where employee and employer alike can benefit from implementing a plan. These benefits may also expand to include reduction of taxation of both the business and employee relative to Long-Term Care legislation, making the coming years particularly interesting for Executive Benefit offerings in this product segment.

Given their relative simplicity and utility across multiple business entity types, Section 162 Bonus Plans stand out as an attractive structure for businesses evaluating implementing an ABTLC plan for their key employees. Please see Figure 1: Section 162 Bonus Plan Mechanics During Employment for additional details on these arrangements.


Figure 1: Section 162 Bonus Plan Mechanics During Employment


In the example outlined in Figure 1, the employer gives its employee an annual bonus amount equivalent to the annual cost of the policy premium. The employee owns the policy and will need to pay income taxes on the bonus, just as they would for any compensation received from their employer. The employer may also choose to compensate the employee with a bonus that covers the annual premium plus the income taxes due by the employee. This is commonly referred to as a double bonus. To incentivize longevity with the company, the employer may choose to spread premium-payment bonuses over five, 10, or more years, as well as restrict access to the policy in other ways that incent the employee to remain with the company. If the employee stays with the company for the required amount of time, they will own a fully funded policy

During the balance of the employee’s career, they continue to enjoy the valuable coverage, knowing that they have an important piece of a comprehensive financial plan in place. Should they need care before or in retirement, the benefits from the policy flow as outlined in the top section of Figure 2: Section 162 Bonus Plan Mechanics at Claim and/or Death. Given that the employee owns the coverage personally, they receive the benefits directly from the insurance company per the terms of the life insurance policy. Depending on how their particular claim ultimately plays out, there will likely be some level of remaining death benefit that would be paid to the employee’s named beneficiaries at their death, as illustrated in the bottom half of Figure 2.


Figure 2: Section 162 Bonus Plan Mechanics at Claim and/or Death


It’s important to note that this is but one approach to offering these benefits as part of a key employee’s benefits package. Businesses interested in further evaluating a plan should fully investigate alternative funding strategies that may be more advantageous for their business entity type or support other objectives they may wish to accomplish by offering a plan.

Tax Considerations:

  • Bonus amounts are generally tax-deductible to an employer
  • Bonus is considered taxable to the employee
  • Long-term care benefits are generally received income tax-free
  • Death benefit is income tax-free to the beneficiary
  • Death benefit amount may be included in employee’s estate for federal estate tax purposes

Table 1, Section 162 Bonus Plan Cash Flows, shows the cash flow requirements for the business allocating $10,000 per year to an ABLTC Benefit Plan for one employee, as well as the net cost to the employee under a single bonus arrangement. As stated previously, the company could elect a double bonus structure that would increase the outlay by the company but would reduce the employee Net After-tax Cost to $0.

Table 1: Section 162 Bonus Plan Cash Flows

The Long-Term Care benefits associated with these cash flows will vary based on any number of factors, but assuming a 55-year-old male with a couple’s discount, this policy should provide a monthly benefit amount of approximately $6,000.

It’s also possible for the employee to elect to contribute some of their own assets to the policy, resulting in richer monthly benefits and/or a longer benefit period.

Possible Additional Benefits to the Business and Employee

In an era that sees an increasing number of states either implementing or evaluating state-mandated Long Term Care plans, there are additional potential benefits to both the business and the employee implementing an ABLTC Executive Benefit plan. In states like California, the taxes associated with the pending legislation include not only a payroll tax paid by the employee, but also a tax paid by the business. Given that both parties are facing some sort of possible expense related to the public long-term care option via taxation, there may be a greater appetite for allocating those dollars to a benefit offering that would be viewed positively by the employee.

While the specifics of the California legislation remain to be determined, private coverage that qualifies for an opt out of the public plan could directly address some of the major challenges this type of legislation presents to highly compensated individuals. Primary among these is the total amount paid in tax over an employee’s career. For highly compensated individuals, even a modest tax rate can translate to a massive total tax burden over their working years. Implementing a private LTC insurance plan, however, could offer two compelling advantages: Likely superior benefits and a guaranteed cost. These advantages may also be available to the business if their employee opting out of the public option also eliminates the portion of the tax paid by the business. In addition, employees will likely place much more value on a benefit from their employer that provides superior economics and benefits, reinforcing the intent of these types of Executive Benefit Plans.

The bottom line of this discussion is rather straightforward: Today’s job market is putting pressure on businesses to offer compelling benefit packages. State level Long-Term Care plans are forcing employees to purchase Long-Term Care in some fashion, by either participating in a public option or acquiring private insurance. There is a larger need for this kind of coverage with each passing year as the cost of care increases. While it is impossible at this time to determine what, if any, actual cost savings may be available to a business by implementing an ABLTC Section 162 plan, the superior relative value of the plan in the eyes of the participating employees makes offering this type of benefit rather than subjecting the business and the key employees to an unwanted and punitive tax a much more effective use of the business’s capital.