Vol 5 No 1		February 2003

Katt & Company is a fee-only life insurance / actuarial 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. We also assist clients with disability income and long term care insurance. The June 2002 Forbes magazine named Peter Katt as one of only four nationally recognized advisors, stating, "…advisers are well worth the money…[T]hese savants are working for no one but you…" For references please contact us.

Alert and Information

The inherent complexities of permanent life insurance make it a favorite asset for some developers and promoters to use for various promised cutting-edge tax planning schemes that they claim are tax-loopholes, when many of them are nothing more than catch-us-if-you-can tax-avoidance scams that end up getting clients in trouble. Despite the apparent certainty advanced by developers of such schemes, there is no tax authority for any planning that allows income tax deductions for permanent life insurance premiums or for the calculation of a policy's cash value that dramatically increases within several years without reference to future premium payments. A favorite among many dubious developers and marketers is using permanent life insurance within 419A(f) (6) plans, and claiming various levels of premiums that can be deducted. They don't work and eventually the IRS will find the new trick and ring taxes, interest and penalties (to say nothing of the emotions) out of these client-victims. (Indeed, the IRS is enhancing its arsensel to attack these scams with proposed 419 regulations and requirements that taxpayers self-identify themselves to the IRS that they are participants in 419 plans). My November 2002 Journal of Financial Planning column, Protecting Clients from Life Insurance Schemes, lamented the fact that victims of these scams are having a difficult time in litigation because defendants claim ERISA preempts state court jurisdiction and most plaintiff lawyers won't continue a case under ERISA because they don't allow punitive damages and cap plaintiff layers fees. And then along comes the Finderne case (Finderne Mangement Company, Inc. v. James W. Barrett, Superior Court of New Jersey, Appellate Division, Docket No. A-2873-00T2, A-5028-00T5 - for a wonderful commentary on this case go to www.leimbergservices.com). Essentially, the court found ERISA preemption is not available when the plan is only individual benefit plans set up for clients by insurance salespersons for entrepreneurial purposes associated with the sale of life insurance policies. If other jurisdictions adopt New Jersey's appellate court's position we may be well on our way to cleaning up this mess. For a slightly different perspective on this issue please see my November 2002 AAII Journal column, Hard-To-Spot Differences in Tax Loopholes vs. Tax Scams.

Tip

Instead of immediately running to cheap level term insurance for temporary estate tax liquidity life insurance needs, consider using low-load survivorship universal life when your client is in a healthy marriage. Under the unlimited maritial deduction the estate tax isn't due until the second death, therefore using survivorship insurance covers the need. For example, you have clients you would like to have covered for their estate tax liability for the next five to 20 years, during which you expect the family business to be sold or liquidated. The liquidity need is $10,000,000. Both husband and wife are age 50 and in excellent health. 20-year level term on the husband will have an annual cost of around $22,000 and if the wife is insured the approximate cost is $15,000 a year. However, a low-load survivorship UL policy projected to continue for 20 years has a target premium of $7,400 a year. Aside from the premiums being lower for the UL approach there are three other advantages. First, if the need for the liquidity terminates, say, in 10 years the UL policy has a cash surrender value of $43,000 while the term policies have no surrender value. Second, the cost basis in the UL policy can be preserved and used. Lets say the insurance is used for all 20 years. The cost basis is $148,000 ($7,400 x 20). By having at least $1 of surrender value the UL policy can be transferred under a 1035 exchange to a deferred annuity with the client adding, say, $150,000 to it, and all of the gain up to $148,000 will be tax free to the beneficiaries. Admittedly, this use of the cost basis isn't exactly home-run planning, but it is moving the runner from second-to-third. Third, the UL policy can be continued beyond the 20 years (with an adjustement to the premiums of course) without having to convert to a full-load permanent policy most level term policies allow for.