Helen’s objectives:
Helen wants to make sure that her children and grandchildren receive a meaningful inheritance. While Helen expects to receive a 7% return on her investments over time, she is concerned that, in today’s environment, the assets might underperform. For example, if her assets receive only a 5% average annual return over time, her beneficiaries might receive substantially less than her expectations. Assuming a blended income and capital gains tax bracket of 27.5%, that 2% difference in return rate over 28 years could result in a difference of more than $3,000,000 in the legacy for her children. A down market near Helen’s death could have that type of effect on years of wealth accumulation.
Helen’s wealth transfer strategy:
As a hedge against that risk, Helen’s financial professional suggests she take $30,000 each year, or 1% of her accessible assets, and direct the funds to a life insurance policy on her life. She can own this policy outright, although she may want to consider using a trust. If structured properly, life insurance owned by an irrevocable trust will generally keep the proceeds of the life insurance out of the insured’s estate. This will prevent the proceeds from being subject to estate taxation. Estate taxes aren’t an issue for Helen, but for others they could be an issue.
Helen’s results:
Assuming a policy on Helen’s life (a 60-year-old female who receives an underwriting category of preferred non-tobacco user), her beneficiaries might see the following results. Each year’s life insurance premium is $30,000. That may purchase a life insurance benefit of $2,000,000. Helen’s portfolio is reduced slightly due to the premium expense, but the life insurance benefit gives her a potentially more effective transfer strategy.
Additionally, the death benefit will ensure a return of the funds contributed, something few other financial assets can offer.
In effect, by using her assets to buy life insurance, Helen is giving up some upside potential for greater safety in her wealth transfer strategy. By directing this relatively small amount of her net worth into life insurance, she adds a stabilizing element to the dollars ultimately transferred to her family (provided the policy stays inforce).
If Helen received a lower rate of return, using life insurance could help offset the risk of loss or underperformance. Through the purchase of life insurance, Helen has, at least in part, shifted the risk of underperformance from her to the insurance company, provided she continues to pay the required premiums.
Make a difference with life insurance
Ultimately, at her life expectancy, Helen’s purchase of life insurance increases the amount passing to her beneficiaries.
- If Helen continues to receive the expected pretax return of 7% average annual growth, her beneficiaries would gain an additional $137,000.
- If Helen receives a lower pretax return of 5% on her assets, the gain to beneficiaries would be $533,000. In fact, if Helen had invested the $30,000 annual premium at a 5% return, she would have to wait until she was age 93 before the funds would grow to a level greater than the $2,000,000 life insurance death benefit.