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Shielding a Legacy from the Impact of the TCJA Sunset

A well-crafted and effective estate plan will often span generations. Implementing insurance solutions involving later generations who may not have a significant net worth today, however, can be challenging. The impending sunset of the Tax Cuts and Jobs Act at the end of 2025 increases the risk that comes with waiting until receipt of an inheritance to implement an estate plan.

One of the keys to preserving family wealth across generations is designing and implementing estate plans that involve younger generations of the family. Not only does this create the cohesion required for these plans to be maximally effective, but it also allows insurance solutions to be put in place far earlier than might otherwise be possible. In doing so, it can also address some of the challenges presented by insurability at older ages, easing the sting of a lack of insurability in G1, and/or placing insurance on G2 before their health presents a problem. Additionally, the impending sunset of the Tax Cuts and Jobs Act (TCJA) makes multi-generational planning all the more important as a strategy for addressing uncertainty about the future of estate tax exclusion amounts. All of that said, insurance companies can often be reluctant to approve and issue large insurance policies based on future events that may or may not come to pass. Successfully navigating this process requires a higher degree of specificity and plan documentation, reasonable growth assumptions, and an insurance underwriter with a clear understanding of the wealth transfer market.

Those ingredients serve to document G2’s projected net worth at their life expectancy and justify the insurance amount required to meet the corresponding future estate tax liability. A “safe harbor” of sorts for this calculation involves taking G2’s current net worth, inclusive of the projected inheritance, growing at 6% to the client’s life expectancy.

The projected estate subject to tax is then calculated and multiplied by 40% to arrive at the required amount of insurance. The calculation described above must be supported by additional documentation that meet the financial underwriting requirements of the carrier underwriting the application. See Figure 1, Projected Inheritance Calculation, for additional details.



The result in this instance is an insurance need of $15.6M, an amount far in excess of G2’s current net worth. Placing that amount of coverage would be quite challenging without a well thought out process and a carrier who views estate planning in the same manner as the client and their advisors. In addition, the keen observer will note that the calculation in Figure 1 is based on today’s estate tax law despite the fact the Tax Cuts and Jobs Act will expire at the end of 2025 absent action by Congress. This approach of using current law despite what changes the future may hold has been insurance company policy for quite some time. Rather than attempt to forecast what could happen, most will simply assume current law will be on the books forever. That underwriting approach cuts both ways, either helping or hindering planning efforts depending on the current law.

The challenge presented by today’s legislation and what is at best a 50/50 proposition in terms of an extension of the limits under the TCJA would leave a client like the one in our example with an even larger tax exposure. That possibility drives home the need for this type of planning. If, for instance, the TCJA does sunset at the end of 2025, G2’s projected estate tax could balloon to something in the realm of $21M. For clients who have executed this type of planning, that translates to a need for $6M in additional insurance. For those who have done no planning, that amount jumps to over $21M, increasing the risks associated with failing to act now dramatically.

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How to Use Your LTC Premiums to Reduce Your Tax Bill

While tax deductions are available to Long-Term Care Insurance owners the particulars point to a decision between modest tax savings today versus more significant tax savings in the long run.

If we’re honest, there are two things that most people don’t want to spend their hard-earned assets on: Taxes and insurance premiums. That said, the downside risk of not paying either of those expenses is severe enough to motivate many to not only pay their taxes, but also take some risk off the table beyond home, auto, health and life insurance. As an example, Long-Term Care insurance has become another necessity for anyone wanting a high degree of control regarding how they receive care as they age.

That said, Long-Term Care insurance represents one of those rare instances where paying insurance premiums can actually reduce your tax bill. Exactly how to go about achieving those savings will depend on the nature of the coverage as well as the particulars of the client’s tax planning.

In terms of the coverage, there are four factors what will impact how to take a deduction and the size of that deduction:

  • The insurance product must fall under section 7702(b) of the internal revenue code.
  • It also has to have separate charges related to the acceleration of benefits, continuation of benefits and any inflation protection, as well as no cash value related to these elements of the product. Together, this generally eliminates all the Long-Term Care riders available on traditional life insurance products.
  • There are age-based limits to how much a client can deduct. See Table 1 for additional details.
  • The client must itemize, and their total medical expenses have to exceed 7.5% of AGI

Table 1


Itemized Deduction Example:

  • Male, age 55:
    • Annual LTC premium: $5,000
    • Age-based limit: $1,760
    • Deduction = $1,760
  • Female, age 72:
    • Annual LTC premium: $5,000
    • Age-based limit: $5,580
    • Deduction = $5,000

All the factors listed above prevent many from deducting  any of these charges. Fortunately, there is another path for individuals to achieve a similar outcome. If their health insurance coverage includes a Health Savings Account (HSA), the most significant barrier from the list above comes off the table: The need to itemize their taxes.

HSA participants can use their HSA assets to pay the portion of their Long-Term Care Insurance premium attributable to the actual coverage using the same guidelines list above, capped by the age-based limit. Of course, if the client is already max-funding their HSA, then they can simply pay as much of their premium as the age-based limit will allow from those assets, preserving their earned income for other purposes. If they’re not fully funding, however, increasing up their contribution with the express purpose of using those funds to pay their LTC premium is the most straightforward way to achieve a deduction.

There are, however, a number of additional considerations to keep in mind: It may be in the client’s best interest in the long run to let those HSA funds grow versus using them to pay premiums. Long-Term Care costs are not the only costs that rise as the years go by. Out of pocket expenditures increase as well. Further, preserving those HSA funds to pay for treatments that may not be covered by health insurance despite being an appropriate treatment option is also a strategy worth considering.

What’s the bottom line?

Ultimately, there is no single right answer here. If the client is a bit older and itemizes, simply taking the deduction via itemization is a clear winner. Beyond that, it is admittedly a bit more complicated. For clients participating in an HSA or with a seasoned HSA from prior participation, using these funds is a viable tax minimization strategy that should be considered based on not only the particulars mentioned above, but also the balance of their tax planning. In addition, the decision regarding how to pay premiums my vary from year to year as well.

The real advantage of the entire conversation is that these strategies can make Long-Term Care Insurance more affordable, rendering coverage more accessible. In addition, while it is beyond the scope of this discussion, business owners have more tax-advantaged premium payment options available to them, as do employees with access to coverage through their benefits program.

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Flexible Funding Strategies for ILITs

As the sunset of the Tax Cuts and Jobs Act approaches, the need for flexibility when funding estate planning strategies is more important than ever.

In one of life’s delicious little ironies, the phrase “the only certainties are death and taxes” is absolutely false when it comes to estate taxes in this environment. For many clients, the changes on the horizon as the Tax Cuts and Jobs Act (TCJA) sunset approaches will make them unsure of how to plan for multiple possible outcomes: A complete sunset, some sort of extension of the current law, or something in between.

Rather than try to predict what will happen come the end of 2025, the savvy advisor is seeking ways to maintain enough flexibility that clients feel in control of their assets and planning regardless of the outcome. This typically involves the three cornerstones of estate planning: Trust language, policy ownership and funding strategies.

In terms of funding strategies, the central themes in this environment continue to be maintaining gifting capacity to the degree it still exists for the client, avoiding liquidation of assets and the associated taxes where possible, and maintaining a high degree of control of assets for as long as possible. Accomplishing all of those objectives often moves the client away from simply paying premiums via annual exclusion gifts and into some type of financing strategy.

While many automatically think about commercial premium financing as soon as financing is introduced, the reality is that there are multiple different strategies, each with their own strengths and weaknesses, available to clients:

  • Private Financing
  • Commercial Premium Finance
  • The “Dual Loan” Approach
  • Private Split Dollar

Two of these, Private Financing and Private Split Dollar, may represent the strategies with the highest degree of control and least significant concerns.

How Private Financing Works:

  • The Grantor creates an ILIT, which will apply for and own the insurance
  • The Grantor enters into a loan agreement with the trust, lending the trust the funds needed to pay premiums. This is often a lump sum.
  • The trust pays the premiums. Any excess funds are invested and/or used to make interest payments back to the Grantor.
  • The Grantor has the ability to forgive the loan, making it a gift.

How Private Split Dollar works:

  • ILIT purchases a Survivorship Life Insurance Policy.
  • The Grantor advances annual premiums under a collateral assignment split dollar arrangement on a limited pay basis.
  • The advances create a receivable owed to the Grantor.
  • The Economic Benefit cost is treated as an annual exclusion gift.
  • The Grantor has the ability to forgive the receivable, making it a gift.

The last element of both of these approaches, the ability to render the loan a gift if conditions warrant, make them incredibly attractive when facing high levels of uncertainty. In today’s environment with a shorter timeline before decisions about completing any gifting under current estate tax law, the Private Financing approach may be the most suitable. This assumes, of course, that there is significant liquidity today in order to make the loan. If not, then the Private Split Dollar approach may be necessary.

The bottom line is this: Regardless of the financing approach, trust language, and policy ownership, it’s time to have these conversations with clients who may find themselves with increased estate tax exposure as a result of the sunset. For some clients, this may represent the first time they have found themselves with a potential estate tax liability. The educational process required to make them comfortable moving forward with this kind of planning will take significant time, as will the implementation of any planning. That makes the twenty months or so remaining before the sunset seem like a very short amount of time.

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Strategic Income from Downside Protected Life Insurance

A more thoughtful approach regarding when to take income from downside-protected Life insurance assets can make a massive difference in retirement outcomes for clients. In this case, it prevents the depletion of the client’s assets prior to their death, turning a zero balance into a healthy, $1.5MM portfolio.

History is full of periods of market volatility. Most recently, the extended bull market ended in spectacular fashion in 2019, ushering in a period of volatility that continues to make clients nervous. For those still working to accumulate wealth, it can be argued that this period represents an interesting buying opportunity. Taking advantage of that opportunity can expose clients to swings in both directions, causing some to think twice before committing assets. For others, including those closer to or in retirement, volatility is a threat to a successful retirement.

Volatility at the wrong time can turn what appears to be an adequate rate of return into a portfolio that could be exhausted before the client’s death. This suggests an obvious question: What’s the alternative? Exiting the market in an attempt to avoid market losses is not a viable solution, as market returns remain critical to a successful retirement over the long term. Asset allocation strategies can only do so much, leaving financial instruments with some level of downside protection as a critical element of addressing the risk of excess volatility and sequence of returns. Table 1, Volatility in Retirement, shows what volatility can do to a retirement portfolio in very clear terms.

Table 1: Volatility in Retirement¹

Individuals using life insurance products as part of their retirement planning strategy, however, may have an elegant solution at their disposal regardless of where they find themselves in their retirement planning journey. Clients still accumulating assets can use their life insurance position to either stay in or enter the market with the comfort of some level of downside protection. For those in retirement, a properly designed and funded life insurance strategy can both avoid negative volatility and participate in positive volatility, resulting in a very different retirement outlook.

Over the recent past, the insurance product of choice for this approach was often Indexed Universal Life (IUL), offering a 0% floor and some level of upside, limited by either a cap, spread, or participation rate. While those products remain an option, they are not the only option available from the insurance segment. Today’s insurance market offers not one, but three unique products that absorb or avoid some level of a market downturn while also offering some sort of positive return. They each have their own unique “value proposition” that may ultimately make one more suitable than the others for a specific client’s risk tolerance and other elements of their retirement planning.

  • Whole Life: Guaranteed positive return each year. Modest additional upside
  • Indexed Universal Life: Complete protection against market risk. Market-linked upside subject to a cap, spread or participation rate. Account values are subject to “losses” based on policy charges in years that hit the floor
  • Buffered Strategies in Variable Life: Protection for some level of market risk before client account values are impacted. Market-linked upside subject to a cap. Caps in this segment are typically higher than those in the Indexed UL segment. Like the IUL segment, account values in this category may be reduced by policy charges in years that trigger the buffer.

Clearly, clients can position some of their assets in vehicles that can avoid some or all negative volatility. There is, however, a cost to that downside protection in the form of limits on the upside potential they offer.

What’s less clear is the impact any of the three approaches may have on retirement portfolios broadly, as well as how to think about using these products when in retirement. Table 2, The Impact of Downside Protected Assets addresses the first question of the impact on retirement portfolios.

Table 2: The Impact of Downside Protected Assets²

Table 2 shows the superior outcome for the client. By taking an equivalent, non-taxable distribution from a life insurance contract in the years following a down market, the client not only enjoys the same level of purchasing power, but also has a portfolio value that remains in excess of $1.5MM through age 90. The importance of this can’t be overstated in an era of elevated inflation and the spiraling cost of care later in life. That said, two elements of the strategy remain an open question: How to fund the life insurance strategy and which product type is the most suitable? Before those questions can be addressed, it is critical to understand how much additional capital would be required in the traditional investment portfolio to achieve a similar outcome? In the example used here, the client would need a starting account balance of $2,475,000 to support the desired income stream and a projected ending account balance at age 90 of $1,560,000.

With that additional capital requirement in mind, it is then possible to project how much capital the three insurance strategy alternatives, Whole Life, Indexed UL and a Buffered VUL might require to achieve the outcome shown in Table 2. ³

  • Whole Life: $200,000
  • Indexed UL: $170,000
  • Buffered VUL: $130,000

From a client outcome perspective, all three of the insurance solutions deliver a positive outcome:

  • The client’s income goal is met, including a small increase each year to offset some level of inflation
  • The client’s assets are preserved, with a projected portfolio value over $1.56MM higher than the original plan
  • Based on the lower capital requirements of the insurance strategy (As little as $130,000 versus $475,000), the client may also enjoy more net spendable income throughout the accumulation phase when compared to simply accumulating more assets in a traditional investment account.

There remains, however, one additional topic to consider and that is which of the three possible insurance solutions is the right one to use? As tempting as it is to try to identify an empirically superior solution, the reality is that the best product will vary depending on the client, their risk tolerance, and the rest of their portfolio. While three product solutions are mentioned specifically here, there are some additional nuances to consider based on the age of the client at policy inception.

First, for the younger client, a VUL that offers indexed or buffered strategies may, in fact, be the most appropriate. Given that this strategy does take some time to “season” clients in their 40’s are ideal prospects and would have enough time on their side to consider using traditional subaccounts at policy inception, with a subsequent transition to indexed or buffered strategies as they near retirement. For clients who may be a bit older, full exposure to downside risk may not be appropriate, making one of the downside protected strategies most suitable. Clients getting a later start may need to let the insurance policy “season” a bit longer or allocate more capital to the strategy.

Regardless of how those nuances play out, the end result is yet another powerful argument for the increased use of insurance products in the retirement planning process based on their unique risk/reward profile and favorable tax treatment.

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Can You Spend the Same Dollar Twice?

The answer, of course, is no. That said, this is exactly what some clients may think is possible with the “Swiss Army Knife” approach to Indexed Universal Life case design. The typical illustration, regardless of the illustrative rate used, displays the maximum level income possible. One of the underlying assumptions in that illustration is nearly always the use of participating loans. While there is nothing inherently wrong with that approach, it does become a problem when the policy’s living benefit features are an important part of the sale.

When considering these products, most clients will undoubtedly be attracted to the value proposition of a single product that offers death benefit protection, supplemental retirement income and a backstop of benefits should they need care later in life. What they don’t understand, unless the advisor takes the time to fully explain policy mechanics, is all of these benefits effectively come from the same pool of money. Their expectation is that they have all three of these benefits and that they are independent from one another. The living benefits, in their mind, are in addition to any income they may take from the policy. The reality is that the use of loans to take income out of the policy effectively eliminates the client’s ability to access the living benefits like a Chronic Illness or Long-Term Care Accelerated Benefit Rider (ABR).

The primary reason behind this is in the fine print of these riders. Virtually all of them include a provision that requires a partial repayment of any outstanding loans with each benefit payment under the ABR. Even with a modest loan balance, the end result is a net payment to the client, reduced by the loan repayment, that is less than the income they are already taking from the policy. In addition, most ABRs have a provision that forbids taking loans and benefits under the ABR in the same year. Clients have to take one or the other. Figure 1, below, demonstrates how quickly an outstanding loan balance becomes an issue: The net benefit from the ABR can fall below that of the income they are already taking as quickly as the 4th year of the income phase. This essentially eliminates any increased income from the ABR, exactly the opposite of their expectation.


Fortunately, there is a solution. It requires changing the way income is illustrated and ultimately taken from the policy. Rather than illustrate income via loans from day 1, illustrate income via withdrawals to basis before any loans are taken. This immediately defers the onset of one of the factors driving this issue: The accumulation of a loan balance that has to be repaid when on claim. This is but one of a handful of case design and management best practices to follow as well:

  1. Illustrate income via withdrawals. This defers the accumulation of a loan balance and produces a lower illustrated income.
  2. Begin income later in life. This again pushes out the time when a loan balance will begin to accumulate, preserving meaningful ABR benefits.
  3. If and when the clients needs care, resist the temptation to immediately file a claim. Given that most claims last for less than five years, simply beginning to take a larger income projected for five years via loans may produce a larger net payment to the client than available ABR benefits. This also avoids the paperwork and potential delays in accessing funds that can stem from even the most efficient claims process.

As effective as those strategies may be, they do not truly address the underlying issue of all policy benefits coming from the pool of money. For the client who truly wants all three of these benefits, a multi-policy solution that addresses all three needs is undoubtedly going to be a superior solution. It will, however, require a greater financial commitment, which some clients may not be able or willing to make. If that’s the case, then a properly structured and managed single product strategy is a great start to managing these planning risks.

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The Tax Time Bomb of Self-Funding Long-Term Care Costs

Undoubtedly, there are clients with enough assets to pay for care should they need it later in life. That said, this may be one of those instances where just because you can, doesn’t mean you should. More often than not the decision to self-fund is due, at least in part, to not wanting to think about the possibility of needing care. It also completely omits the planning component by focusing strictly on the funding.

In terms of funding, simply transferring this risk to an insurance company is going to provide a significant discount. What is often not factored into the decision to self-fund, however, is the impact of taxes. Unless paying with cash from a checking account that doesn’t accumulate interest, every time the client liquidates an asset to pay for their care, they are creating a taxable event. At either capital gains or ordinary income rates, the tax burden this creates can grow quickly.

There are additional factors that can make this a more significant problem:

  • The majority of Americans’ wealth is tied up in their qualified plan assets. Withdrawals from these accounts to pay for care are 100% taxable at the prevailing ordinary income rates at both the state and federal level.
  • Consumers holding annuity assets often have these “earmarked” as the asset they will use to pay for care. The last in, first out tax treatment of these assets again results in a 100% taxable amount at ordinary income rates until such time as all gains are exhausted.
  • The resulting increased income can also push the client into a higher tax bracket

Some might think that the taxes can be offset by deducting the cost of care. Maybe, but maybe not. There are two complicating factors here:

  • Not all costs are deductible. Only the actual cost of care. In the case of an assisted living facility, that can exclude rent, as an example, which is the majority of the actual cost. If full time memory care is needed, then all costs, including things like rent, may be deductible.
  • Even if the cost is fully deductible, there is the 7.5% of AGI threshold that needs to be met before any deductions can be taken. This also assumes the client is itemizing, and for the high net worth that is likely the case. For those of more modest net worth and a simpler financial life, the current standard deduction is high enough that they may not itemize their deductions.

So, what’s the moral of the story? Self-funding only makes sense if the real cost of the approach is superior to an insured solution. That determination needs to include all contributing factors to the cost of both self-funding and an insurance solution. Fortunately, there are ways to mitigate the taxes that may be triggered by either approach. In the case of an insurance solution, things like the Pension Protection Act and case designs with extended premium payment durations can be used to minimize or even eliminate taxes at the time of purchase. In the case of self-funding, finding loss harvesting and other strategies can reduce the net taxes due.

The crux of the matter is asking a very simple question of those who plan to self-fund: Have you thought about which assets you will use to fund care, and did you consider the tax ramifications of your strategy? The subsequent conversation may point to an insurance solution more often than you think.

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Avoiding the Tax Double Whammy

Two factors, one already in place, the other on the horizon, will combine to erode assets left to IRA beneficiaries at an unprecedented rate. This “one-two punch” can be avoided with a straightforward planning approach designed to minimize the tax by shielding IRA assets from taxation.

Most are well aware of the massive amount of wealth held in retirement accounts. What may not be as well known outside the financial planning community is how significantly those assets will be eroded as they pass to the next generation. Simply considering the income tax implications points to the SECURE Act of 2019 as an accelerant of sorts. Most IRA beneficiaries no longer have the ability to “stretch” the distribution of the inherited IRA over their lifetime. Instead, the IRA has to be distributed over a ten-year period.

The second element of this planning challenge is on the horizon: The sunset of the Tax Cuts and Jobs Act (TCJA) at the end of 2025. While much of the discussion of the sunset focuses on changes to estate tax laws, for IRA beneficiaries the changes to income tax rates may be more important. Why? Just as they are being forced to take large, taxable distributions form their inherited IRA, the rate at which those distributions are taxed is due to increase when the TCJA sunsets.

This has major implications for both those who are in the ten-year distribution phase as well as those anticipating inheriting an IRA.

For those already in the process of distributing an inherited IRA, a quick look at the potential increase in income tax rates based on the TCJA sunset as shown in Table 1 indicates an increase of anywhere from 0% to 4% in marginal tax rates for taxpayers filing jointly as rates revert to 2017 levels. Depending on the rest of the client’s income tax planning, it may make sense to accelerate distributions of the IRA prior to the TCJA sunset to avoid these higher rates.

Those anticipating an IRA inheritance, further accelerating those distributions likely doesn’t help, as it would have to be on such a short timeline that the increased would undoubtedly result in the client jumping up to a higher income tax bracket. For these clients, the panning work has to happen before the inheritance is received.

In this case, the fact that approximately 36% of retirees who withdrew funds from a traditional IRA in 2021 used the money to reinvest or save. The likely cause of these distributions is undoubtedly Required Minimum Distributions that force the IRA owner to liquidate a portion of their IRA each year once they reach a certain age. The question for this discussion is what are these clients doing with the money? Where are they investing it?  From the perspective of the beneficiary anticipating receiving the IRA as an inheritance or the IRA owner concerned about so much of their hard-earned money being lost to taxes, a life insurance policy may be the best vehicle for a few simple reasons:

  • Each premium dollar is immediately leveraged, increasing the amount that passes to the next generation.
  • Life insurance proceeds pass income tax free and there are no rules around distributions once received
  • Life insurance proceeds can also pass estate tax free with proper planning

In short, transforming the tax in efficient IRA into a tax efficient life insurance strategy can avoid the tax double whammy created by the SECURE Act and TCJA sunset by reducing the amount subject to taxation. This tried-and-true planning strategy is more relevant than ever given both current law and the apparent inability of Congress to pass meaningful legislation over the recent past.

1 https://www.wsj.com/articles/retirement-required-minimum-distributions-tips-11668797319 What to Know About RMDs and Retirement Planning, Nov. 27, 2022.

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Don’t Outgrow Your Business Insurance

Best practices exist for a reason, as do products that may cost a bit more but offer superior value. In this real-life example, an insurance solution that is built for the business market would have streamlined a key component of buy/sell agreement management that could have prevented multiple days in tax and appeals court.

It comes as a surprise to no one that insurance assets need to be reviewed periodically. What may be a surprise is how significant a problem could result if you don’t. Case in point? 2023’s Connelly decision. The details of the case are worth understanding (Follow this link for more on the case), but there’s one element of the decision that is particularly important for anyone working with business owners: The court affirmed the IRS’s position that the proceeds of a life insurance policy that funded a buy/sell agreement were includable in the value of the business, rather than offset by the obligation of the business to redeem the deceased owner’s shares under the terms of their Buy/Sell agreement. This increase in the value of the business led to a $1MM increase in estate taxes.

While there are multiple issues involved, the most fundamental called out by the court in their decision focused on the business not following the terms of the buy/sell agreement. Specifically, the agreement called for a “Certificate of Agreed Value” that set the price of the business by mutual agreement on annual basis. Failing that, the agreement called for two or more appraisals to determine the fair market value of the business. Neither of these were done.

After the owner’s death, they parties involved agreed on a value, executed the sale, and proceeded to file the necessary estate tax return. The audit of the return uncovered the lack of compliance with the terms of the buy/sell agreement, resulting in the inclusion of the proceeds of the life insurance in the value of the business and the increased estate tax. The Connelly decision may not be the last word on this, as the Connelly family appealed, and the Supreme Court has agreed to take up the case.

In this case, the amount of life insurance, $3.5MM, was relatively close to the agreed upon value of $3.89MM the family used. This is rather surprising given that the buy/sell agreement was put in place in 2001 and the owner passed in 2013. Their problem would have been far worse if the policy were for significantly less than the deceased owner’s share of the business. The estate tax implications likely would not have changed, but their ability to execute the sale would have been severely compromised. This is where the danger of “outgrowing your business insurance” comes into play.

These business owners are undoubtedly not unique in their lack of periodic review of their buy/sell agreement, the value of the business and any related insurance policies. To make matters worse, there are both insurance solutions and valuation services available that can make that process as painless as possible. All it takes is using an insurance provider that offers products built for this specific purpose, not only insuring the value of the business today, but having a built-in mechanism for both periodic review and commensurate increases in coverage as the business grows.

The first step is to set the value of the business with a formal valuation. This is followed by implementing the funding with life insurance. In each subsequent year, the business owners execute the increase option, including a renewed formal valuation every third year. See Table 1, below, for a description of how this could play out.


The insurance company offering this product will do the valuation at no cost. The end result is a product and process that prevents the fact pattern of the Connelly case from occurring while ensuring the adequate funding of the buy/sell agreement. In short, preventing the business from outgrowing their insurance.

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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.