Blog Archives - PFwise.com

Min Vol ETF Strategies

8/31/2021

Min vol investment choices may help you execute your strategy if you are concerned about a short-term market decline. We have shared a list of min volatility ETFs before, if you want to explore more min vol ETFs, here are the 10 largest by net assets:

iShares MSCI Min Vol USA ETF (USMV)
iShares MSCI Min Vol EAFE ETF (EFAV)
Invesco S&P 500® Low Volatility ETF (SPLV)
iShares MSCI Min Vol Global ETF (ACWV)
iShares MSCI Emerging Markets Min Vol Factor ETF (EEMV)
iShares MSCI USA Min Vol Factor ETF (USMV)
Invesco S&P Midcap Low Volatility ETF (XMLV)
Invesco S&P Smallcap Low Volatility ETF (XSLV)
iShares MSCI USA Smallcap Min Vol Factor ETF (SMMV)
Invesco S&P Intl Developed Low Volatility ETF (IDLV)

Other volatility strategies
There are several other ways that investors may be able to weather an increase in volatility. Bonds, for example, tend to be less volatile than stocks. When the stock market is expected to be more volatile, tactical investors may want to consider increasing their bond allocation. It is worth noting that the bond market is not immune to volatility.

High-yielding stocks are another opportunity that investors can explore. The income component of high-yielding stocks tends to make these investments less volatile than more cyclical stocks, which have lower or no dividend yield. Of course, the 2008 financial crisis highlights that even this strategy may not be immune to severe market stress.

You could also consider industry/sector-specific mutual funds that have historically exhibited lower volatility, relative to the broad market, as well as managed account solutions—particularly those with a defensive strategy.

Additionally, there are several options strategies, including straddles, strangles, and other spreads, which can be used to take advantage of expected market volatility.

How to Analyze IUL's Costs and Its Values - Part C

8/30/2021

We will continue the case study from last blogpost.

How to evaluate IUL's values against its costs?

The best metric for this evaluation is to calculate the IUL's Internal Rate of Return (IRR) - it calculates the product's return after subtracting all the costs.

Let's look at the best case and worse case scenarios, respectively.

The best case scenario
If the insured dies very young, this IUL product would have the best IRR, that's because the power of life insurance is at play here. For example, if the insured dies at year 2, the IRR would be 330% ($277,953 death benefit to beneficiaries).

The worst case scenario
The worst case scenario happens if the insured dies very old. Let's see if the insured dies at age 100 - after putting in $200,000 premiums.

He would have taken out tax-free policy loans of $629,930 ($17,998 times 35 years). The IRR would be 4.56% or a taxable equivalent of 6.81% assuming he was in the 33% tax bracket.

Where are the Costs?
We assumed 5% return for this policy, why IRR is only 4.56%? That's because all the costs.

Given the average mutual fund expense ratio of 1%+, the expense of 0.44% is not really high.

Furthermore, this 0.44% expense buys the life insurance over the insured's lifetime, so if he should die young in the early years, his heirs would get multiples of what he puts in, i.e. leverage. If he dies old, the leverage has burnt off, but the 0.44% expense is still not too bad given the expenses in other investment options.

Another way to look at IUL's value

Another way to look at an IUL's value is to check its IRRs under cash surrender values in year 20, 30, etc. If the difference between the IRR and the illustrated rate is less than 1%, it's still a not too bad option when compared with other investment choices.

How to Analyze IUL's Costs and Its Values - Part B

8/29/2021

In last blogpost, we discussed IUL's major costs. Now we will analyze the values one could get from an IUL product, after these costs.

A Hypothetical Example

Let's say we have a 45-year old male who is going to pay annual premium of $10,000 per year to age 65. His goal is to achieve maximum ax-free distribution/loans once he retires at age 65.

The policy design and assumptions

First, we will optimize cash value from this policy by solving for the minimum non-MEC death benefit so we could minimize Cost of Insurance. This solves for $211,000 initial death benefit.

For purpose of loan duration, let's assume from age 65 till age 100.

Furthermore, let's assume only 5% growth rate for this IUL and guaranteed wash loans (zero-interest net cost loan) to age 100.

In solving for the maximum loan amount, we get annual amount $17,998.

If this insured person dies at age 82 (life expectancy), he would have gotten 17 years of tax free income - approximately $305,966. His beneficiary would get approximately $275,397 of death benefit. This is a total of more than $580,000 tax free to him and his beneficiaries.

So, how to analyze the value of this IUL policy? We will discuss in next blogpost.

How to Analyze IUL's Costs and Its Values - Part A

8/28/2021

One of the biggest issue with permanent life insurance products, especially Index Universal Life products (IULs), is IUL's costs. This blog will use a real example to analyze IUL's costs and compare the costs with IUL's values to determine if IUL truly delivers values or not.

IUL's 3 big costs

IUL has 3 big costs:

Premium Loads: when you contribute the premium to the IUL policy, there is usually a premium load which comes off the top of the "gross premium" to arrive at the "net premium".
Per Unit/Thousand Charges: these charges are a factor of the face amount, which is usually deducted monthly from the policy over a period of years. The duration and severity varies by product, buy a typical per-thousand charge happens in the first 10 years.
Cost of Insurance (COI) / Mortality Charges: these are usually the most significant charges over the life of the policy and are deducted monthly. A good policy design could help minimize COI charges, for example, minimize non-MEC death benefits or option two death benefit switching to option one in the optimal year.

In next blogpost, we will use a case study to compare an IUL's costs with the values the policyowner would get.

Original Medicare vs Medical Advantage - Part IV

8/27/2021

In last blogpost, we compared original Medicare and Medicare Advantage, now we will show you who might benefit from the original Medicare the most.

Who benefits from original Medicare the most?

Generally, original Medicare is popular among people who:

Travel often or have more than one residence
Want flexibility in choosing doctors and hospitals
Prefer to manage their own health care
Live in areas that have limited or no Medicare Advantage providers
Don't mind managing multiple insurance policies

Original Medicare vs Medical Advantage - Part III

8/26/2021

In last 2 blogposts, we discussed original Medicare and Medicare Advantage, now we will compare these two options.

How many enrolled in each option?
About 60% of enrollees in original Medicare and 40% in Medicare Advantage.

What are the joining processes for each option?
Original Medicare: beneficiaries sign up for part A and part B directly with Medicare, and purchase part D directly from private insurers.

Medicare Advantage: an enrollee needs to first sign up for Medicare part A and part B with the government in order to receive the Medicare card. Then fill out an enrollment form with the plan in Medicare Advantage to join.

Any restrictions in each option?
In original Medicare, you may choose any doctor or hospital that accepts Medicare.

In Medicare Advantage, you have to use doctors and hospitals in its networks in order to be covered.

How about costs for each option?
For original Medicare, the government adjusts premiums, deductibles, and copays that apply to all enrollees nationwide. You are responsible for 20% of health bills.

For Medicare Advantage, private plans also adjust premiums, deductibles, and copays annually, so you need to review each autumn when adjustments are announced. Generally these plans have lower copays and out-of-pocket costs than original Medicare.

Any coverage differences for these two options?
The original Medicare pays for most basic medical needs but has some gaps (see first blogpost's discussion).

The Medicare Advantage coves everything original Medicare does, some plans also cover dental, vision and hearing, as well as prescription drug costs. Some also provide services such as transportation, home-delivered meals and health-related home improvements.

In next blogpost, we will summarize which option best fits for what kind of enrollees.

Original Medicare vs Medical Advantage - Part II

8/25/2021

In last blogpost, we discussed what the original Medicare covers and not covers.

What are the other costs for original Medicare?

Roughly 80% of original Medicare enrollees buy supplemental (or Medigap) insurance policies to protect themselves from oversize out-of-pocket costs if big health issues emerge. Those who don't are typically very poor (Medicaid will cover most of their incremental costs) or the very rich (who can afford to pay any incremental medical costs).

In 1990, Congress passed a law establishing 10 standard Medigap insurance policies (plans A through J).

What is Medicare Advantage?

In 1997, Congress approved a competitor to original Medicare, known first as Medicare+Choice (M+C), then renamed Medicare Advantage in 2003.

Part C plans allowed HMOs and PPOs into the Medicare system. So now Medicare enrollees face a choice: original Medicare (managed directly by the fedeal government), or Medicare Advantage (through a private sector provider).

We will compare these two choices in next blogpost.

Original Medicare vs Medical Advantage - Part I

8/24/2021

These couple of blogposts intend to help you decide which one fits your needs better - the Original Medicare or Medicare Advantage.

What does original Medicare cover?

The original Medicare covers 4 major areas:

Part A: this covers most costs of hospitalizations. It also pays all or most of the costs for up to 100 days of extended care in a nursing home or rehab facility after a hospital stay. For most enrollees, no monthly premium cost, but you must pay for some costs for every hospital visit.
Part B: this covers doctor visits, medical tests and other outpatient services. Most enrollees pay for a monthly premium for this coverage, and there is financial penalty if you don't enroll when you are eligible to enroll.
Part D: this covers most prescription drug costs. Unlike Part A and B, this benefit is purchased from private insurers, so enrollees need to shop to see which plan fits their needs, healthy situation, and budget.
Preventive care: with the pass of Affordable Care Act, Medicare now provides enrollees with free preventive care, including mammograms and prostate screenings.

What doesn't original Medicare cover?

There are some major coverage gaps in original Medicare, including:

Residential nursing home care
Dental care
Vision care
Hearing services
Cosmetic and other elective surgeries
Care outside of the U.S.
20% (or more) of your health care costs

In next blogpost, we will discuss other costs for original Medicare.

Estate Planning Checklist

8/23/2021

As you manage the estate planning basics, it can help to have an idea of what to expect. Here’s an estate planning checklist from TD Ameritrade that can help you make the most of your money.

2 Ways to Look at Annuity

8/22/2021

Below is a excerpt from an article at thinkadvisor.com, it advises financial advisors to give 2 perspectives about annuity:

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“From an economist perspective, annuities are wonderful because they give you guaranteed income for as long as you live,” she explains. “But a lot of people see them as unfair because they think ‘I’m going to give this money to an insurance company. And if I live a long time, that’s great. But if I don’t, the return on investment might not look as appealing.”

What does she recommend advisors do to help their clients work through this type of thinking? Two options may help, she says. One is to walk through the reasons an annuity is like a pension plan, she says.

“If they think of an annuity is like their own personal pension that they’ve been contributing into for many years, it starts to feel a lot more palatable than if it’s just they handed $100,000 to an insurance company,” she says. “Just reframing [the idea] a little bit and getting people to think of it more like a pension than thinking of it as a financial product that you’re hoping to get a return on investment for can change the mindset.”

She also recommends “preconditioning” clients when they are younger, and earmarking a portion of retirement savings for an annuity.

“You do want to give people the option to back out if things have changed [by retirement], but laying the groundwork of a the plan, and [saying] ‘this is how we’re going to do this, and this money is earmarked to go into an annuity,” I think helps.”

3 Investments to Keep in Retirement

8/21/2021

Below is an article from fool.com, it mentions three investments to hang onto once retirement rolls around.

1. Dividend stocks
The great thing about dividend stocks is that they allow you to make money in two ways. First, like all stocks, dividend stocks have the potential to gain value over time. You could buy shares of a given dividend-paying company today at $400 apiece, and in 20 years, they could end up being worth $1,200 apiece.

But dividend stocks also, not shockingly, pay dividends, generally on a quarterly basis. That means getting access to a steady stream of income during retirement, which is particularly appealing to me.

If there's a year when the stock market underperforms and I can't sell stocks at a gain, I can fall back on the dividend payments I receive and use them as income to pay my expenses. And if that's not necessary, I can always reinvest my dividends for added growth.

2. Municipal bonds
Municipal bonds are those issued by states, cities, and other localities (as opposed to corporate bonds, which are issued by corporations). Municipal bonds tend to pay less interest than corporate bonds, but the benefit is that the interest payments you collect won't be taxable at the federal level. Plus, if you buy municipal bonds issued by your home state, you won't pay state or local taxes on that interest income, either.

Here's why that's important to me. Right now, I have my retirement savings in a SEP IRA and solo 401(k). Both accounts give me an up-front tax break on my contributions, but withdrawals during retirement will be subject to taxes. Because of that, it's important for me to have a source of income that doesn't add to my tax burden.

Plus, bonds are generally a less volatile investment than stocks. During retirement, I feel I'll need to keep a large chunk of my portfolio in bonds to avoid exposing myself to undue risk.

3. S&P 500 index funds
Once I retire, I suspect that my risk tolerance might wane in the context of investing. And that's why I think S&P 500 index funds are a good bet.

Index funds are passively managed funds that aim to match the performance of the benchmarks they're tied to. S&P 500 index funds track an index that's comprised of the 500 largest publicly traded stocks (as measured by market capitalization). The index itself offers instant diversification, which is a good thing to have in your portfolio as a retiree. And that's a great way to keep gaining wealth while getting some protection against market downturns.

The choices you make for your investment portfolio could set the stage for a rewarding retirement. Though I'm not planning to wrap up my career anytime soon, right now, all of these investments seem like a good bet for me, and they may be a good bet for you, too.

How to Use IRA to Invest in Early Stage Companies Properly

8/20/2021

For entrepreneurially minded individuals, the potential to generate investment returns and wealth creation through the founding and growth of a business is often unrivaled. The caveat, of course, is that rapid growth businesses also face substantial taxation on that growth when they are eventually sold. Accordingly, when such individuals have retirement account assets – effectively legal tax shelters – the question arises: “How can I shift some of the value of my fast-growing business into my retirement account?” or better yet “Can I use my tax-free Roth IRA to invest into early stage growth companies?” (as was highlighted in a recent ProPublica article about Peter Thiel’s early stage investments into PayPal and Facebook to create a whopping $5 billion Roth IRA).

Because the reality is that while a Roth IRA can certainly own shares of stocks – including privately held companies that are not (yet) publicly traded – there are limitations on who an IRA can buy shares from, and who can be compensated by an IRA-owned company, under the so-called “Prohibited Transaction” rules.

At the highest level, the Prohibited Transaction rules restrict an individual from using their (Roth) IRA to engage in various types of transactions with certain “Disqualified Persons”. Which is important because, in the case of an IRA owner, failure to abide by these rules results in a deemed distribution of the entire IRA in which the transaction occurs as of January 1 of the year in which the Prohibited Transaction occurs (causing a forced liquidation of the entire retirement account and forfeiting its tax-preferenced status altogether!).

Among the Prohibited Transaction rules outlined in IRC Section 4975, IRAs are prohibited from buying/selling property to/from, lending/borrowing to/from, or furnishing/receiving goods, services, or facilities to/from, a Disqualified Person. Disqualified Persons are also prohibited from using IRA assets for their own personal benefit. Finally, Disqualified Persons who are also fiduciaries must avoid dealing with the income or assets of an IRA for their own account, or (in general) receiving any consideration from the IRA.

Critically, an IRA owner is always a Disqualified Person, and fiduciary with respect to their own IRA. Other Disqualified Persons, with respect to an individual’s IRA (who may or may not be fiduciaries), are the individual’s spouse, ancestors, lineal descendants, and any spouse of a lineal descendant. In the event an IRA owner, along with those related Disqualified Persons owns 50% or more of a business, then the business, itself, also becomes a Disqualified Person, along with its officers, directors (and persons with similar responsibilities), 10% or greater owners, and employees earnings 10% or more of its total wages.

The end result of these rules is that in order for a Roth IRA to invest into an early stage growth business, it must have someone besides the IRA owner (or his/her family members) to buy the shares from (as they cannot be contributed in-kind to an IRA). Which means businesses that are fully owned by the founder (and/or their family members) are effectively ineligible to be purchased inside of an IRA! And even if the business isn’t fully owned by Disqualified Persons, if the IRA owner (and other family members) own 50% or more of all shares, the business cannot even issue new shares to the IRA and must find other non-Disqualified-Person owners to buy from (and even then, there is a risk that the IRS will scrutinize the transaction further under the self-dealing rules for IRAs).

Interestingly, though, for individuals who want to start a new business owned by an IRA, 100% IRA ownership is achievable. As the Tax Court has repeatedly determined that since prior to the formation and capitalization of a company, it has no owners and thus, cannot yet be a Disqualified Person! Accordingly, the company can issue 100% of its shares/interests to an individual’s IRA.

However, even when a business is fully owned by an IRA, entrepreneurs must still be cautious with respect to their compensation. Because in situations where the business is owned 50% or more by an individual’s IRA, “control” essentially always exists (either directly or indirectly), and thus receipt of compensation personally should be universally avoided (to avoid running afoul of the self-dealing rules for IRAs). Though at the same time, absent the receipt of compensation, an individual can still create a Prohibited Transaction through the provision of services (‘sweat equity’) to their IRA-owned business. As while an IRA owner can perform certain administrative and decision-making duties on behalf of an IRA-owned business (e.g., paying bills of the IRA-owned business with IRA money, deciding on investments to be made by the company), it cannot do the work of the business.

Ultimately, the key point is that while IRAs can be used to purchase private, non-public companies, the Prohibited Transaction rules significantly restrict both who can sell shares to the IRA, what compensation the entrepreneur can receive when working for an IRA-owned company, and even the ability to contribute sweat equity to an IRA-owned company. Which is important to navigate, given the harsh tax consequences associated with the Prohibited Transaction rules!

Exchange Life Insurance for Annuity - Part B

8/19/2021

In last blogpost, we discussed the reasons for exchanging life insurance policies to annuities. Now we will take a look at a case study.

Life Insurance to Annuity Exchange
Exchanging a life insurance policy for a NQ annuity is a permitted nontaxable exchange, provided the:

Owner of both contracts is the same, and
Annuitant on the new annuity contract is the same as the insured on the old life insurance policy

A Case Study: Joan Jumps from Life Insurance to Annuity
Joan, age 55, owns a permanent life insurance policy. It’s underperformed her expectations. She’s considered her reasons for ownership carefully and decided she no longer needs it.

Her situation:

She’s paid total premiums of $160,000 ($16,000 annually for 10 years). That’s the policy’s cost basis. But the policy’s cash value is only $115,000.
If she surrenders the policy, Joan receives no tax benefit from having paid more for the policy than it was worth at the time of surrender.
If Joan executes a 1035 exchange of the $115,000 cash value into a NQ annuity, her cost basis of $160,000 can be recovered tax-free from the annuity payout.

If Joan desires income now, she could exchange the life policy for a single premium immediate annuity (SPIA). She would buy the SPIA with a $115,000 premium (the life policy’s cash value) and the SPIA would have a $160,000 cost basis. She would have an exclusion ratio of 100% and, provided she lives that long, would receive her payments tax-free for nearly 30 years (29.6 to be exact, representing her remaining life expectancy). Payments received after that point will be fully includible in her taxable income. In year 23 Joan would recover the total premium paid.

If Joan prefers income later, she could exchange the life insurance policy for a deferred annuity.

Finally, Joan can also add additional funds from her savings. By doing so, she’ll increase the monthly amount of protected lifetime income she’ll receive from the immediate or deferred annuity. Any additional premium would also be recovered tax-free from the annuity payouts.

Exchange Life Insurance for Annuity - Part A

8/18/2021

Questions to Consider

Do you have an old cash-value life insurance policy that has served its purpose?
Would a protected retirement income stream – one you cannot outlive, regardless of market conditions – now better address your needs?
Do you know you can exchange that old policy – generally tax free – for an immediate or deferred annuity?

Consider Your Options
Of course, you can always surrender the old policy. But, if there’s any gain in the policy, you’ll need to include that amount in your gross income on your tax return. There it will be taxed as ordinary income. Gain is generally determined by subtracting the total premiums you’ve paid (your cost basis) from the policy’s current cash value.

Even if there’s no gain in the policy, there may still be a good reason not to surrender it. If you’ve paid more into the policy than its current cash value, you’d be walking away with a loss that you can’t claim on your tax return. Exchanging a policy that’s “underwater” (i.e., its cash value is less than the total premiums paid for it) for a nonqualified (NQ) annuity can:

Preserve the cost basis and thereby
Allow it to be recovered tax free from the annuity payouts

A life insurance policy might be underwater for a variety of reasons. One reason might be lower-than-expected interest rates on whole life or universal life policies. Another reason might be lower-than-expected subaccount values in variable life policies.

In next blogpost we will discuss life insurance to annuity exchange.

Do I Need to Pay Net Investment Income Tax?

8/17/2021

The Net Investment Income Tax (NIIT) became effective January 1, 2013, to help fund the Affordable Care Act. This additional 3.8% federal tax can impact taxpayers who exceed the modified adjusted gross income (MAGI) thresholds of $200,000 for single filers, and $250,000 for married couples filing jointly. The 3.8% NIIT applies to the lesser of net investment income or the excess of MAGI over the threshold amount. However, taxpayers may be able to avoid the NIIT by carefully managing their MAGI levels and net investment income levels.

Planning Considerations
Consider strategies that lower MAGI and net investment income.

Tax-deferred annuities: If you do not need income now and would like for some of your assets to continue growing tax-deferred, a nonqualified annuity allows you to defer the growth. Because no income is being paid out, the deferred growth will not be subject to NIIT. However, if you start taking distributions, the growth will increase your MAGI and may be subject to NIIT.
Charitable giving: Gifts made to charities may lower your overall MAGI.
Roth IRAs: Qualified distributions from Roth IRAs are not subject to income tax, so it will not increase your MAGI. o Municipal bonds: Income from these bonds is generally not included in MAGI.
Your workplace retirement plan: Distributions from most 401(k)s, 403(b)s, and other employer retirement plans are not considered net investment income, but will increase your MAGI.

Are Your Investments Taxed Diversified?

8/16/2021

Use the following checklist to help determine how tax-diversified your investments are.

Living Benefits Payouts and Taxes - Part B

8/15/2021

In last blogpost, we showed that taxes usually not apply for living benefits payouts. Below we will show some exceptions.

Third-Party Ownership
Living benefits are normally free from income tax even when the insured is not the owner. Some exceptions to the income tax free nature of living benefits when a third party is the owner of the contract are:

business related policies. Terminal and chronic illness long term care benefits may not be exempted from income tax.
if the policy has become subject to the transfer for value rule. While critical illness benefits may fall outside the statutory transfer for value rule, they may also become taxable if the owner acquired the policy for money or in exchange for services or property after inception of the policy.
corporate owned policies. These may cause or increase the Alternative Minimum Tax (AMT) by including annual increases in cash values and death benefits in AMT tax.

MEC with a Long Term Care Rider
Generally, MEC’s follow the LIFO (last in, first out) rules for taxation so that any loans or withdrawals from a MEC result in taxable gains being distributed first before the nontaxable return of basis. However, when LTC benefits are paid out of a MEC from a LTC rider, the benefits received by the insured for long term care are not taxable because they are considered LTC rider benefits rather than withdrawals from the MEC.

In addition, one can do a tax-free 1035 exchange from a MEC contract to a MEC contract with a LTC rider and thereafter receive benefits during lifetime for long term care without experiencing taxation of the benefits.

Lapsing a Policy After Receipt of Living Benefit
The general rules on surrender determine the tax consequences of allowing a policy to lapse, even after payment of an accelerated death benefit. When 100% of the policy face amount has been accelerated as a terminal illness benefit, the base policy and all riders will terminate.

When a policy lapse occurs after a chronic illness claim or long term care claim, there is no taxable income related to prior living benefit payments as they are considered a tax-free accelerated death benefit. Similarly, prior critical illness benefit payments are not taxable on a later lapse of the policy. (NOTE: This differs from the tax treatment of the lapse of a policy with an outstanding loan in excess of basis in the policy. In that scenario, the outstanding loan balance is included as part of the amount realized, and the result is additional ordinary income to the policy owner.)

Qualified Plans
If life insurance with accelerated death benefit riders is owned by a qualified plan, the plan documents should address living benefit riders.

Long term care/chronic illness and critical illness riders may not be considered by the IRS to be permissible incidental benefits in a qualified plan.
Terminal illness riders in a qualified plan require attention. To the extent that a life insurance policy inside a qualified plan has cash value when the participant is terminally ill, the distribution of living benefit payment from the plan could be viewed as a pro rata distribution of death benefit and cash value.

Insureds and plan trustees should consult with their tax advisors to evaluate the tax consequences of plan ownership of a life insurance policy with living benefit provisions.

Summary
With the increasing popularity of hybrid life insurance products with chronic, critical, terminal and long term care benefits, it is important to be aware of the issues that may arise due to tax consequences of these living benefits. Policies owned by businesses, policies in qualified plans, and any other policies not owned by the insured all require careful review so that the value of these benefits is understood and realized.

Living Benefits Payouts and Taxes - Part A

8/14/2021

Over the past two decades, life insurance products have come to include benefits payable during the life of the insured as well as at death. More recently, hybrid life insurance with long term care (LTC) or chronic illness riders has proved popular in the marketplace. This early payout is called a living benefit (also known as accelerated death benefit, or ADB).

Living benefits on a policy may be triggered when the insured experiences a qualifying chronic, critical or terminal illness. Exact requirements for living benefits depend on life expectancy and the terms of the life insurance contract. However, since the income tax free receipt of life insurance proceeds is usually described as dependent on the death of the insured, the taxation of these living benefits has raised questions.

Below we will examine some of the potential tax implications with regard to qualifying health events and policy ownership. In general:

Terminal illness or chronic illness/long term care benefits should be income tax-free if the death benefit would have been income tax-free upon the death of the insured. These benefits would be taxable to the business for business-owned policies.
Critical illness benefits should generally be income-tax free when premiums are paid by the individual insured rather than by an employer.

The table below compares some of the differences in taxation based on ownership of the life insurance policy:

In next blogpost, we will discuss some special cases that the above table may not apply.

International Marriage and the U.S. Estate Tax Mistake

8/13/2021

International marriage brings some additional complications, but one complication that many couples may not be aware of is the different treatment under the U.S. gift and estate tax laws. Simply stated, there is no unlimited marital deduction for transfers to a non-citizen spouse.

Most planners are aware that there is not a U.S. estate tax on assets transferred to a surviving U.S. citizen spouse due to the unlimited marital estate tax deduction. For this reason, many do not think that there is any particular need for estate planning for couples with less than $10.86 million in assets. However, this can be an expensive oversight and a missed opportunity for those couples where one or both spouses are not U.S. citizens. The non-citizen spouse does not receive the benefit of the estate tax marital deduction for U.S. estate taxes due on a deceased spouse’s estate. Estate taxes are due after transfers of $5.43 million from a U.S. resident or citizen, unless they establish a qualified domestic trust (QDOT). Naturally, there are many more couples with more than $5.43 million than couples with $10.86 million.

Definition of a Qualified Domestic Trust (QDOT)
A QDOT provides deferral of estate taxes during the surviving spouse’s life. The assets in the QDOT will be subject to estate taxes when distributed to meet an immediate, substantial financial hardship related to the health, maintenance, education or support of the survivor spouse or of a person whom the surviving spouse is legally obligated to support. Income from the QDOT assets may also be distributed to the survivor spouse without owing estate tax, but this distribution is subject to income tax by the spouse. Moreover, at the death of the surviving spouse, the deferral of estate tax provided by the QDOT ends. The remaining QDOT assets are subject to estate taxes at the rate and in the amount that would have otherwise been due as part of the first decedent spouse’s estate. If the assets have appreciated in value, the ultimate estate tax due may be greater than if the full amount had been subjected to estate taxes at the time of the first spouse’s death. The QDOT itself will also require a U.S. trustee—possibly an institutional trustee—necessitating annual trustee fees and legal fees to establish the trust.

Life insurance as a solution
Life insurance can be a better planning option than a QDOT. Life insurance is often paid for using tax exempt gifts. For example, spouses who are both US citizens can freely transfer assets between themselves without owing gift taxes. However, while there is no marital deduction for a gift to a non-citizen spouse, the annual exempt gift allowed is $147,000 per year, indexed for inflation. This compares to an annual gift tax exempt amount of $14,000 to a non-spouse. This annual exempt gift can be used to fund a life insurance policy owned by the spouse or held in an irrevocable life insurance trust (ILIT).

In many cases, the amount of life insurance that can be purchased with this amount will cover potential future U.S. estate taxes. The death benefit will be free of U.S. income taxes to the beneficiary as well as estate taxes in the decedent insured’s estate, so long as the decedent did not hold any incidents of ownership in the policy at death. When life insurance death benefit is available to cover the deceased spouse’s estate taxes, a QDOT may not be necessary to defer estate taxes and the assets and income of the deceased’s estate can be used without restriction. The surviving spouse does not need to turn to a QDOT trustee for money.

This article addresses the basics of estate planning for married couples with diverse citizenships and U.S. estates. Many additional factors come into play when working through considerations for a specific couple, including estate tax and income tax treaties with the country or countries of citizenship and residence for the couple, laws of succession in the involved countries, and the overall estate planning goals of the couple.

Two Typical Estate Planning Strategies and a Case Study - Part B

8/12/2021

In last blogpost, we discussed 2 typical estate planning strategies, and showed a couple that faces real situations. Now we will discuss the solution for this couple.

STAYING CLEAR OF THE CLIFF
As it turns out, Robert and Becky’s state estate taxes would be significant. The New York estate tax threshold is $5.85 million in 2020 and will increase with inflation each year thereafter. For those with estates worth less than $5.85 million who die in 2020, no New York estate taxes are paid. New York also has a state estate tax “cliff” that must be considered. For estates that exceed the exemption amount by less than 5%, taxes are only owed on the amount over the threshold. Beyond the cliff, estates with a value of more than 105% of the annual exemption amount are then taxed on the entire estate value.

If we assume Robert and Becky’s existing $10 million net worth increases at a conservative rate, in 20 years the estate’s projected net worth would be an estimated $20 million.

The following table below considers two different sets of scenarios of what could happen if Robert were to die unexpectedly today, in 2020:

Scenario #1: Assumes an “all-to-spouse” will without portability of the federal exemption at the first death. Portability requires the timely filing of a federal estate tax return at the first spouse’s death (IRS Form 706).
Scenario #2: Assumes federal portability is elected at the death of the first spouse, and an amount equal to the New York exemption amount is transferred at the first death to a “B” trust.

As this hypothetical case study shows, by having the necessary planning conversations now and putting a strategy in place, Robert and Becky can eliminate their entire tax bill!

Two Typical Estate Planning Strategies and a Case Study - Part A

8/11/2021

There are two typical estate planning strategies:

Strategy #1: For smaller and simpler situations, pass all assets to the surviving spouse outright by the use of the unlimited marital deduction (“All to Spouse Will”).
Strategy #2: For more sizable estates, consider establishing a “B” trust at the death of the first spouse to pass the unused federal estate tax exemption amount of the first spouse to die to the “B” trust.

Structuring the estates either way postpones any federal estate taxes until the death of the second spouse. Both arrangements are feasible options, but the use of the “B” trust keeps the appreciation between deaths from being included in the surviving spouse’s estate. Portability of the exemption of the first spouse to die, when available, should not be overlooked at the first death. And even when it is used at the federal level, it may not be available at the state level, resulting in a different state planning need. This is illustrated in the following case study

A Case Study
Meet Robert and Becky, a hypothetical married couple residing in New York:

Robert, age 58, owns a small manufacturing company
Becky, age 55, vice president of a local bank
$10 million combined net worth
Familiar with the federal estate exemption amount and don’t believe estate taxes are a concern, as their combined estate is below $23.16 million in 2020 and would not be subject to federal estate taxes

NOT SO FAST
There are three potential problems:

The couple’s current net worth is $10 million, but what will it be at death when estate taxes would be payable?
The current federal exemption is $23.16 million in 2020 per couple, but that is scheduled to be reduced to approximately $13.18 million in 2026 and $17.06 million in 20 years assuming 2% inflation.
Robert and Becky have ignored any state estate taxes that would be owed to the State of New York, which may be significant.

Keep reading for the solution for this couple that would completely eliminate the federal and state inheritance taxes.

The Impact of State Estate and Inheritance Taxes on Estate Plans

8/10/2021

Often people may think that estate planning is only for the very wealthy. Even affluent people might think they don’t need an estate plan because of the high federal estate tax exemption. However, there are often two critical components to estate planning that people are likely overlooking:

The federal estate tax exemption is subject to change - With the passing of the Tax Cuts and Jobs Act of 2017, the federal estate tax exemption doubled to $11,580,000 in 2020. This increase is temporary, though, and the exemption is scheduled to revert to approximately $6.59 million in 2026. Are you aware of today’s increased exemption thinking about what might happen when that drastic decrease occurs? Are you also taking the potential growth of their estates into consideration?
The impact of state estate taxes and inheritance taxes - Even if a decreased federal estate tax exemption will not be a concern for you, have you considered the impact state estate taxes and inheritance taxes might have on your wealth transfer plans? It may come as a surprise to you that currently there are 17 plus DC states that impose an estate or inheritance tax.

Risk Capacity and Risk Attitude Could Be Different

8/9/2021

It's probably not surprising that there could be a big difference between one's risk capacity and one's risk attitude and risk perception, as this article points out.

The main takeaways from this article are:

Risk capacity must be measured separately from risk attitude/tolerance.
Risk capacity is evaluated as part of the financial planning process.
Risk attitude is best evaluated via a “psychometrically” designed questionnaire.
Risk perception shifts and must be managed constantly.
An integrated approach allows the planner to optimally address the client’s overall risk profile.

Reasons to Consider Tax-Free Bonds

8/8/2021

An article from thestreet.com discusses several reasons why people should consider tax-free bonds:

Here is the reality - there is not a lot of value in short-term bonds today, but keeping a significant portion of the muni allocation in shorter-term bonds and in cash provides the opportunity to lengthen maturities if rates rise during the second half of the year or in early 2022.

In addition, there are opportunities to enhance yields by investing in lower-quality debt — either the lower tiers of the investment-grade universe or in non-investment grade municipal bonds. Selectivity in this segment of the bond market is critical, so investing with an actively managed fund rather than an index fund or ETF is recommended.

HSA and Medicare - Be Careful of the Pitfall

8/7/2021

HSA eligibility rules state you can't contribute or receive contributions from your employer to your HSA when enrolled in any part of Medicare. Otherwise, you could be subject to tax penalties.

If you're currently contributing to your HSA, and you plan to start your Medicare coverage the month you turn 65:

Make sure all HSA contributions end before your 65th birthday month.
If your birthday is on the first of the month, make sure you stop your contributions by the beginning of the month before your birthday month.

If you enroll in Medicare after turning 65, your coverage can become effective up to 6 months earlier. You and your employer will need to end your HSA contributions up to 6 months before enrolling in Medicare since Medicare back dates your Part A coverage from the date you enroll.

If you continue to work after age 65, and you or your employer is still contributing to an HSA:

Stop making contributions to your HSA up to 6 months before applying for Medicare Part A only or Part A and Part B or starting your Social Security retirement benefits.
When you receive Social Security retirement benefits, your Part A coverage is back-dated 6 months (but no earlier than the first month you're eligible for Medicare) to give you 6 months of back-dated benefits. If you contribute to your HSA during those 6 months, you may face a 6% excise tax and an income tax for those contributions.
This "6-month lookback" starts when you enroll in Medicare or begin your Social Security retirement benefits. However, you can withdraw those contributions by the end of the tax year to avoid the excise tax.

This HSA restriction leads some working past age 65 to defer Medicare and maintain their current employer-based health insurance coverage so they can keep contributing to their HSA until they retire.

Remember, after you enroll in Medicare, you can use existing funds in your HSA for qualified medical expenses, including your monthly premiums for Parts A, B, C, and D (but not Medigap premiums).