Vol 4 No 2		April 2002

Katt & Company is a fee-only life insurance advising firm. We work with clients throughout the U.S. - primarily by phone, mail, email and telecopy. Typically, we assist clients buying life insurance, those who need existing policies reviewed and managed, and in support of litigation. For references please contact us.

Alert

The failure to clearly understand the macro planning foundation of your clients' life insurance can cause years of wasted time and frustration as it is repeatedly attacked by aggressive insurance agents looking to redo it. Last year I was referred to a client (lets call him Mr. Freeman, who is 79 and in excellent health) because for the past five years the same insurance agent had criticized his life insurance policies, trying to replace them with a new policy. Mr. Freeman's estate planning attorney has done hall-of-fame work by getting Mr. Freeman's business worth some $25 million to his son, bonds worth some $12 million and $13 million of participation whole life to his daughter, and leaving Mr. Freeman with $13 million in tax-free bonds. The newest claim being made by this persistent insurance agent was that the new universal life policy he was touting had lower guaranteed premiums relative to level death benefits compared to the whole life. (Please see Vol. 3, Number 2 of our Alerts, Tips & Information newsletter for why such guarantees are irrelevant). The question of whether this would be a good idea took up a great deal of time by each of the agents that had sold the whole life policies and Mr. Freeman's attorney and CPA. The problem was that they were looking so intently at the micro issues they forgot to step back to see they were dealing with an elephant.

There are three reasons to use life insurance associated with estate planning. They are: liquidity; to equalize an inheritance between heirs; and wealth transfer. Mr. Freeman has no liquidity need, he has already equalized the inheritance between his son and daughter and he has already completed his wealth transfer. The only rational issue regarding this life insurance is whether the projected yield (premiums-to-death-benefits) on the policies owned by his daughter represents a good use of the income she is receiving from the bonds Mr. Freeman has given to her. After assessing several options for the policies Mr. Freeman recommended that his daughter pay the full premiums because the projected yield at his life expectancy (age 91) is 7.4%, reducing to 5.9% at policy maturity (age 100). These yields are higher than the yields on the tax-free bonds his daughter is buying with her investment income. The recommended replacement policy was not nearly as good a value as the existing policies. Once Mr. Freeman realized how his daughter should be using these policies he no longer was a candidate for sales pitches about replacing these participating whole life policies.

Tip

Participating whole life can use policy dividends to either buy paid-up-additions (PUA) increasing the death benefits or dividends can reduce premiums with the death benefits remaining level. An issue that frequently comes up is once the need for the life insurance coverage has diminished (e.g., because children have grown up and are no longer financially dependent or non-liquidity assets have been sold) should participating whole life premiums continue to be paid out-of-pocket or via policy dividends? The answer depends on three factors. First, what is the insured's health? If in poor health continuing to pay the premium is conclusive. Second, is the insured an investor? And third, what is the projected yield on the benefits purchased if the premiums continue to be paid? Recently a client, 71, and his CPA wanted guidance on this issue because he had sold his business and no longer needed the coverage. The insured is in good health and has significant income. So the question was what projected yield could he expect for continuing to pay the premiums. This was done by isolating on the difference in projected death benefits if the premiums continue to be paid versus having dividends pay them. The projected income tax-free yield at age 73 is a robust 48% dropping to 18%, 12%, 9.6% and 8.6% in five year increments. When the projected yield is likely to be higher than other investments that might be made the astute financial decision is to continue paying the premiums, allowing dividends to increase the policies income tax-free value.