April 20, 2018

Irrevocable Life Insurance Trust

In the United States, proper ownership of life insurance is important if the insurance proceeds are to escape federal estate taxation. If the policy is owned by the insured, the proceeds will be subject to estate tax. (This assumes that the aggregate value of the estate plus the life insurance is large enough to be subject to estate taxes.) To avoid estate taxation, some insureds name a child, spouse or other beneficiary as the owner of the policy.

There are, however, two drawbacks to having insurance proceeds paid outright to a child, spouse or other beneficiary.

  • Doing so may be inconsistent with the insured’s wishes or the best interests of the beneficiary, who might be a minor or lacking in financial sophistication and unable to invest the proceeds wisely.
  • The insurance proceeds will be included in the beneficiary’s taxable estate at his or her subsequent death. If the proceeds are used to pay the insured’s estate taxes, it would at first appear that the proceeds could not be on hand to be taxed at the beneficiary’s subsequent death. However, using insurance proceeds to pay the insured’s estate taxes effectively increases the beneficiary’s estate since the beneficiary will not have to sell inherited assets to pay such taxes.

The solution to both drawbacks is usually an irrevocable life insurance trust.

A life insurance trust is an irrevocable, non-amendable trust which is both the owner and beneficiary of one or more life insurance policies. Upon the death of the insured, the Trustee invests the insurance proceeds and administers the trust for one or more beneficiaries. If the trust owns insurance on the life of a married person, the non-insured spouse and children are often beneficiaries of the insurance trust. If the trust owns “second to die” or survivorship insurance which only pays when both spouses are deceased, only the children would be beneficiaries of the insurance trust.

What Is Quantitative Easing

Since the 2008 recession, the phrase quantitative easing has been used throughout the media extensively. Well, what is quantitative easing?

The term quantitative easing (QE) describes a monetary policy used by central banks to increase the supply of money by increasing the excess reserves of the banking system. This policy is usually invoked when the normal methods to control the money supply have failed, i.e the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero.

A central bank implements QE by first crediting its own account with money it creates ex nihilo (“out of nothing”). It then purchases financial assets, including government bonds, agency debt, mortgage-backed securities and corporate bonds, from banks and other financial institutions in a process referred to as open market operations. The purchases, by way of account deposits, give banks the excess reserves required for them to create new money, and thus hopefully induce a stimulation of the economy, by the process of deposit multiplication from increased lending in the fractional reserve banking system.

Ordinarily, the central bank uses its control of interest rates, or sometimes reserve requirements, to indirectly influence the supply of money. In some situations, such as very low inflation or deflation, setting a low interest rate is not enough to maintain the level of money supply desired by the central bank, and so quantitative easing is employed to further boost the amount of money in the financial system. This is often considered a “last resort” to increase the money supply. The first step is for the bank to create more money ex nihilo (“out of nothing”) by crediting its own account. It can then use these funds to buy investments like government bonds from financial firms such as banks, insurance companies and pension funds, in a process known as “monetising the debt”.

Quantitative easing is seen as a risky strategy that could trigger higher inflation than desired or even hyperinflation if it is improperly used and too much money is created.

Quantitative easing runs the risk of going too far. An increase in money supply to a system has an inflationary effect by diluting the value of a unit of currency. People who have saved money will find it is devalued by inflation; this combined with the associated low interest rates will put people who rely on their savings in difficulty. If devaluation of a currency is seen externally to the country it can affect the international credit rating of the country which in turn can lower the likelihood of foreign investment. Like old-fashioned money printing, Zimbabwe suffered an extreme case of a process that has the same risks as quantitative easing, printing money, making its currency virtually worthless.

Naming Beneficiaries In A Life Insurance Policy

Life Insurance And Estate Planning

Let’s take a look at this VERY important topic.

If you are like most people then you’ve worked hard your whole life and want to be sure that as much of it as possible gets passed down to your kids and grandkids when you are gone. Well, Uncle Sam has a different plan in mind. Although as of 2010 no one really knows what is going to happen to the estate (death) tax. Most are willing to bet that it isn’t going to stay at 0% but probably fall somewhere between 30% and the historical 50%. Therefore it is important to plan ahead and take actions to minimize the amount that Uncle Sam is going to affect the inheritance you intend to pass along. Life insurance is a good way to solve some of these problems by the following:

  • Maintain surviving family’s lifestyle – life insurance death benefits may help by paying off debt and providing a lump sum of cash from which your family can draw in the event of your death.
  • Divide and distribute your estate equitably – for example, if you have someone who will be the heir to your business that is worth a couple million dollars, you could provide another heir with a couple million in life insurance death benefit proceeds.
  • Reduce or eliminate gift and estate taxes1 – for example, a member of senior generation transfers their residence at a reduced gift tax cost to a Qualified Personal Residence Trust (QPRT) and retains the right to live in the residence for a specified term; the residence eventually passes to the junior generation without any additional gift tax – as long as the grantor survives the specified retained term; junior generation purchases life insurance policy insuring senior generation to insure against the risk that the residence may be brought back into the grantor’s estate if the grantor dies during the retained term. Similar programs can be set up for Grantor Retained Annuity Trusts (GRATs), Family Limited Partnerships (FLPs), Private Annuities and many others.
  • Solve liquidity needs – to pay for administrative costs, gift taxes and estate taxes. Oftentimes, estates are composed of illiquid property or property such as collectible artwork, jewelry and other family heirlooms that heirs may not wish to sell to pay expenses. Life insurance can be used to provide the necessary liquidity to pay the expenses associated with your estate.

Life Insurance Dividends

Many life insurance policies today have a provision allowing the policyowner to participate in the favorable experience of the insurance company through dividends. Most, but not all, of these participating policies are sold by mutual life insurance companies rather than by stock companies. Policies that do not pay dividends are called nonparticipating (nonpar) policies.

Many of the dividend paying companies pay the dividends annually. The policyowner usually is offered several options for the settlement of these dividends. The following is a list of possible dividend payment options:

  • Cash dividend
  • Accumulation at interest
  • Paid-up additions
  • Reduce premium
  • Accelerated endowment
  • Paid-up option
  • One-year term option

When dividends are possible in partcipating policies, it is common for clients to believe that the dividends are earnings similar to those associated with stocks. But dividends are a return of premium and therefor are not taxed. And dividends are never guaranteed. Let’s take a closer look at the dividend options.

Cash dividend option- the insurance company simply issues a check to the policyowner.

Accumulation at interest- the policyowner can let dividends accumulate at interest with the insurance company. If the insured policyowner dies then the accumulated dividends and interest are paid to the beneficiary.

Paid-up additions -when a policyowner chooses to use dividends as a single premium to buy additional life insurance protection. The amount of paid-up addition per $1 of dividend is based on the insured’s age at the time the paid-up addition is purchased. No new policies are issued. The base policy is simply amended to reflect the additional paid-up values. Each of the additions will also develop cash value. The face amount and the additions make up the total death benefit. Proof of insurability is not required.

Reduce premium dividend option- the policyowner can direct the life insurer to apply the dividend towards the next premium due on the policy.

Paid-up option- the option allows the policyowner to pay up the policy early. For example, the insured has a 20-pay life policy. By using the dividends over the life of the policy, it may be paid up after 16 or 17 years.

One year term dividend option- directs the life insurance company to use the dividends on the policy to purchase term life insurance. The term policy is for one year.

Life Insurance Nonforfeiture Options

Many years ago, life insurance policies were structured so that if the owner allowed the policy to lapse, they simply forfeited (gave up) the excess amounts paid in as premium. Today, most laws operate with the standard nonforfeiture law that prescribes any cash value accumulation must be made available to the policyowner if they stop making premium payments.

The amount of cash value and the rate at which it accumulates depends on the type of policy and may vary from company to company. But, in most states, a permanent policy at least has some cash value by the end of the third year. There are three common nonforfeiture options:

  • Cash surrender value
  • Extended term insurance
  • Reduced paid-up insurance

The policyowner can receive the cash accumulation as a cash payment but the life insurance protection will cease. The cash surrender value is the amount entitled to the owner at the time of surrender before maturity. The cash value is determined by a formula established by law. A portion of each premium payment is allocated to the policy reserve, which is a fixed liability of the insurance company. The balance of the premium is used to cover certain expenses such as acquisition costs, administration expenses, and agent’s commissions. The life insurance contract is heavily loaded with expenses initially, thus there is no cash value in the early years of the policy.

With the extended term option, the policyowner can use the policy’s cash value accumulation as a single premium to purchase paid-up term life insurance in an amount equal to the original policy face amount. The length of the term life insurance depends on the net cash value. Typically, the extended term nonforfeiture option goes in to effect automatically if the owner isn’t available to make a choice of simply fails to exercise an option.

With reduced paid-up option, the policyowner essentially uses the cash value of a present policy to purchase a single premium insurance policy at attained age rates for a reduced face amount. There are some important things to keep in mind before choosing this option:

  • Once the face amount of protection has been determeind, it remains the same for the duration of the contract. the new policy will build cash values for the policyowner
  • No further premiums need be paid on the reduced policy- it’s paid up because of a single premium policy
  • the new protection is computed at the attained age of the insured
  • A full share of expense loading is usually not included in the premium on the reduced coverage because the cost of setting up the overage is greatly reduced

Please note that reduced paid-up policies are of the same type of insurance as the original policy, except all riders, including those for disability and accidental death, are eliminated.

Of the three nonforfeiture options for life insurance discussed here, the extended term option provides the most life insurance protection the quickest. And it is important to remember that if a cash value option is chosen, the policyowner looses all life insurance protection.

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Life Insurance Policy Settlement Option

Often times people spend a lot of time on determining what type of life insurance they want and how much of it. But an important topic that is often overlooked is life insurance policy options.  Policy options give the life insurance contract flexibility to meet the needs of the insuring public. Of particular value are the settlement, nonforfeiture, and dividend options available under a life insurance contract.

Settlement Options

At one time, life insurance policy proceeds were paid only in the form of a lump-sum cash payment. This often created as many problems for the beneficiary as it solved. A beneficiary who is the sudden receipient of a large amount of cash may not know what to do with it or how to invest it. Or they may irresponsibly go on a spending spree and broke in a short time. To avoid situations such as the insurance industry developed methods by which the settlement could be paid in forms other than a lump sum. Many policyowners don’t even realize that an alternative exists! When a settlement option is chosen, the proceeds of the policy are left with the company. The insurance company invests the proceeds and guarantees that the funds will earn interest. The advantages of a settlement option are clear:

  • The insurer invests the money, relieving the beneficiary from the task of managing and investing the funds
  • The money is “safe” with the insurance company
  • Interest earnings are guaranteed

The beneficiary can receive the proceeds in a manner that best suits their needs unless the policyowner specifies an irrevocable settlement option. Without the irrevocable option, the beneficiary can choose one of the frequently used optional modes of settlement:

  • Interest only
  • Fixed-Period installments
  • Fixed-Amount installments
  • Life income

Under the interest only option, the life insurance company keeps the proceeds of the policy for a limited time and invests them for the beneficiary, paying the earned interest as income to the beneficiary. The policy option can allow the beneficiary to withdraw some portion of the principal or it can be set that they cannot until a certain number of years have been reached. Money left with a company will go to either the deceased beneficiaries estate or the secondary beneficiary named in the policy.

Under the fixed period option, the beneficiary receives a regular income for a specified period (i.e. 10,20,30 years). Under this option, the principle gradually decreases to zero. The amount that the beneficiary receives will depend on the principal amount, the interest earned on the principal, and the length of time.

Under the fixed amount option, the payee receives payments but the length of time is not specified. The payments continue until the combination of principal and interest has been exhausted.

The life income option provides for payment of installments for the entire lifetime of the payee. Just as with an annuity, there are at least four distinct methods in which these installments can be paid:

  • straight life, in which the payee receives a specified income for as long as they live
  • refund annuity, in which an income is paid for the lifetime of the payee and to the second payee if the first payee dies before receiving an amount equal to the full proceeds
  • life income certain, in which the payee receives installments for life and a second payee receives the the payments if the first payee dies within a certain period of time 5,10, or 20 years
  • joint and survivor life income, in which two payees are recipients of the income of the lifetime of the first payee and the surviving payee the recipient of income of a lesser amount

Withdraw Provision

Usually a withdrawal provision is used in conjunction with settlement options. Under this provision, the proceeds of a policy are held by the insurance company and earn interest, the insured has the right to withdraw the funds left on deposit with the insurer at any time. the beneficiary may withdraw only a limited amount each year.

Payor Rider

What is a payor rider?

A payor rider is often used in juvenile life insurance policies. It states that if the payor (person paying the premiums) of the policy dies or becomes disabled before the child has reached a specified age (i.e. age 21 or 25) the insurer will waive all further premiums until the child reaches that age.

This makes it possible to guarantee that a juvenile life insurance policy will accomplish what its owner wants it to. Simply put, the child will not be without an insurance policy if something happens to the parent or guardian.

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Why Should I Purchase Permanent Life Insurance

Permanent life policy provides lifelong insurance protection. The policy pays a death benefit if you die tomorrow or if you live to be a hundred. There is also a savings element that will grow on a tax-deferred basis and may become substantial over time. Because of the savings element, premiums are generally higher for permanent than for term insurance. However, the premium in a permanent policy remains the same, while term can go up substantially every time you renew it.

There are a number of different types of permanent insurance policies, such as whole (ordinary) life, universal life, variable life, and variable/universal life. In a permanent policy, the cash value is different from its face value amount. The face amount is the money that will be paid at death. Cash value is the amount of money available to you. There are a number of ways that you can use this cash savings. For instance, you can take a loan against it or you can surrender the policy before you die to collect the accumulated savings.

There are unique features to a permanent policy such as:

  • You can lock in premiums when you purchase the policy. By purchasing a permanent policy, the premium will not increase as you age or if your health status changes.
  • The policy will accumulate cash savings.
  • Depending on the policy, you may be able to withdraw some of the money.

You also may have these options:

  • Use the cash value to pay premiums. If unexpected expenses occur, you can stop or reduce your premiums. The cash value in the policy can be used toward the premium payment to continue your current insurance protection – providing there is enough money accumulated.
  • Borrow from the insurance company using the cash value in your life insurance as collateral. Like all loans, you will ultimately need to repay the insurer with interest. Otherwise, the policy may lapse or your beneficiaries will receive a reduced death benefit. However, unlike loans from most financial institutions, the loan is not dependent on credit checks or other restrictions.

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Guaranteed Insurability Rider

The guaranteed insurability rider is an important provision that is gaining in popularity. Several of the life insurance companies now offer it standard with their life insurance policies. Dallas Fort Worth life insurance can help you understand how it works and include it with your life insurance policy.

The guarnateed insurabiity rider allows the policyowner to purchase additional permanent insurance at specified times without having to prove insurability. In other words, you are guaranteed renewal no matter what health you are in! The specified times during the permanent insurance policy could be 3 year intervals starting at age 25 and ending at age 40. Or specified occurences such as marriage or birth of a child.

The amount of insurance that can be purchased on option dates is usually limited based upon the amount and type of the base policy. Premiums for additional coverage based on insured’s attained age at the time additional coverage is added. The rider generally expires when insured attains age 40 at which time the additional premium being charged for the rider ceases being charged.