Maximizing Wealth Preservation: A Guide to Estate Planning with Life Insurance

Estate planning is a crucial aspect of managing your wealth and ensuring a smooth transition of assets to your heirs. One of the most significant concerns for estate owners is the burden of estate taxes, which can consume a substantial portion of your estate’s value, leaving less for your beneficiaries.  For advisors, helping their clients preserve their investments and protect their assets from eventual liquidation is paramount.  Estate taxes may threaten those assets.  This is why life insurance can be a stalwart hedge against the immediate asset erosion that large estates face upon the death of the primary breadwinner.

The Estate Tax Challenge

Currently, the marginal estate tax rate for assets transferred is as high as 40%, and it is triggered at the time of death. This tax is not limited to the income generated by assets but applies to the assets themselves. When estate taxes are paid, the capital available for generating future income and wealth is significantly reduced.

The burden of paying estate taxes can lead to several challenges. Estate owners are required to pay these taxes with liquid assets, which can pose problems for business operations, property management, or the financial well-being of family members who rely on cash for their day-to-day lives. Moreover, when an estate lacks sufficient liquidity, it may force the sale of assets at an inopportune time, resulting in reduced net proceeds and loss of cherished assets such as homes, land, and other legacy assets.

Is Life Insurance Up to the Challenge Posed by Estate Taxes?

Life insurance can provide a valuable solution to the challenges posed by estate taxes. It functions like a financial safety net, offering cash to cover the tax costs precisely when they are due. Just like a bond that matures upon death, life insurance matures with a guaranteed cash payment from the insurance company. The best part is that you can secure this financial protection with relatively low annual premiums.

To put this into perspective, let’s consider an example. For a male and female both aged 59, an estate or trust could pay as little as 1.1% annually to secure a $10,000,000 death benefit. The rates may vary for older clients or healthier, younger insured individuals, but life insurance can be an affordable solution to safeguard your estate from the burden of estate taxes.

The Best Kind of Benefits are Tax-Free

One of the most attractive features of life insurance is that the death benefits are generally free from income tax. If the life insurance policy is owned by a properly drafted trust, such as an Irrevocable Trust,  the proceeds can also be shielded from estate taxes. The after-tax rate of return for life insurance death benefits tends to surpass that of long-term AAA investment-grade bonds, particularly when considered over the policyholder’s life expectancy.

Comparing After-Tax Returns of Life Insurance to Other Investment Options

Let’s examine an example to illustrate the favorable after-tax rate of return offered by life insurance. For a preferred non-smoker couple, both aged 59, with a life expectancy of 33 years, the premium payment is $108,484, and the death benefit is $10,000,000. The after-tax rate of return at life expectancy is an impressive 5.15%, considering a 40% tax bracket.

 

Male and Female age 59 Preferred Non-Smoker (Second Best rate)

Life expectancy: 33 years (IRS Pub. 590-B [2022] App. B Joint and Last Survivor Expectancy)

Premium Payment: $108,484

Death Benefit: $10,000,000

After-Tax Rate of Return at Life Expectancy: 5.15%

Tax Bracket: 40%

Pre-Tax Earnings to Equate to After-Tax Rate of Return: 8.58%

What If They Live Beyond Life Expectancy?

The example above illustrates a favorable after-tax rate of return at life expectancy.  When we go beyond life expectancy the rate of return is less but still comparable to investment-grade bond results.  For those with families who have longer life expectancies, purchasing an increasing death benefit policy would produce a higher rate of return.  As an example, if our 59-year-olds were to live to age 95, the after-tax return would be 5.07% with the increasing death benefit policy.  The following contains the details of the increasing death benefit policy:

Premium Payment: $108,484

Initial Death Benefit: $7,741,388

Death Benefit at Life Expectancy (age 92): $11,429,844

After-Tax Tax Rate of Return at Life Expectancy: 5.78%

Tax Bracket: 40%

Pre-Tax Earnings to Equate to After-Tax Rate of Return: 9.63%

The Added Benefits of Trusts Combined with Life Insurance

Combining trusts with life insurance can provide even greater tax leverage. If life insurance proceeds are shielded from estate taxes, the return required on estate assets to match the after-tax results of life insurance would need to be substantially higher.

For example, assuming a 40% marginal estate tax rate, an asset includible in the gross estate would require $1,666,667 to equal excludable insurance proceeds of $1,000,000.  Therefore, if life insurance is available, life insurance within an irrevocable trust provides a financially sound solution for economically transferring assets to pay estate transfer costs and creating a larger legacy for your heirs.  

 

 

How PenFacs Can Help Estate Owners and Advisors

PenFacs offers solutions that minimize taxes, fund estate tax costs, and reduce financial and personal stress for estate and business owners. Their services include:

• A Due Diligence Review of Insurance Policies to support estate and distribution plans and address ownership and beneficiary issues.
• A Due Diligence review of Insurance Policies supporting Business Continuation Plans, addressing issues affecting business continuation objectives.
• Coordination with legal advisors to craft estate and business planning documents crucial to estate objectives.
• Marketing, underwriting, and brokering insurance solutions that align with estate and business objectives.

Benefits of Using PenFacs Products and Services

There are several benefits to utilizing PenFacs products and services in your estate planning:

• Minimizing and managing the costs of transferring assets at death.
• Reducing financial and personal stress on those depending on the estate’s business and property interests.
• Providing improved solutions to prevent financial stress and forced liquidation of assets in the event of the death or permanent disability of a key person or business owner.

Growing Assets, Securing Legacies

Estate planning is a complex process, and addressing estate tax concerns is a critical aspect of preserving your wealth for future generations. Life insurance, when strategically integrated with trusts and expert guidance from providers like PenFacs, can be a powerful tool to minimize tax burdens, secure liquidity, and ensure a smooth transition of assets. This approach not only helps you safeguard your financial legacy but also provides peace of mind for you and your loved ones.

Required IRS Disclosure:  Any tax advice contained in this communication, including attachments, is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any matters addressed herein.