Below is a potential life insurance strategy that may work for some clients. It may or may not be applicable to your client’s situation, and we recommend that you work in conjunction with your client’s tax professional as well as their tax and/or estate attorney before implementing any specific recommendations related to the client’s personal tax and estate situation. Additionally, the premium rates used in this example are estimates and may vary based on a person’s unique circumstances. Please contact us for a more accurate case design for your clients.
The Challenge
A hypothetical high-net-worth couple, John and Judy, has an estate planning dilemma. Their heirs will face an estimated $20 million estate tax bill on their estate. How can life insurance provide the liquidity their beneficiaries will need to pay estate taxes at the second death?
John, age 55 and Judy, age 40, have four children, all adults. The IRS allows a life insurance policy to be gifted as long as the children are named as beneficiaries on the policy and the policy’s value doesn’t exceed the gift exclusion limit. (If it does, any excess value is allowed by the IRS to be settled later with the final estate.) For the 2023 tax year, they can each gift each child a tax-free maximum of $17,000: $17,000 per person per year = 4 children x 2 parents x $17,000 = $136,000.
Standard Insurance Recommendations
A standard life insurance recommendation might be a joint policy paying at the second death. Alternatively, because of the significant age difference, a common recommendation might be that the couple purchase a single life policy on Judy’s life because she is likely to live longest, with the benefits going into an irrevocable life insurance trust (ILIT).
If the hypothetical cost of a policy that meets their $20 million need is $100,000 per year, this second common recommendation could create a problem, because after John’s death, the cost of the policy will exceed the annual exclusion gift amount of $68,000 for the sole surviving parent of four. With Judy expected to live 15 to 20 years longer than John, significant gift taxes could be incurred if the family is looking to keep the policy in force after John’s death.
A Potentially More Effective Solution – Two Policies
- The first policy would be a $20 million policy on Judy’s life only, guaranteed until she reaches age 85 (John would be 100 then) with a potential annual premium of around $68,000 per year.
- The second policy would be a $1 million policy with an increasing death benefit on John’s life guaranteed until his death, with a potential annual premium of around $68,000 per year.
The Potential Benefits of Two Policies:
While the two policies together would cost approximately $136,000 per year, the cost will drop by half when one of them passes, mirroring the drop in allowable gift exclusions. Based on the 2023 gift tax exclusion rate: 4 children x 1 parent x $17,000 = $68,000.
If John dies first
Should John die before turning 100 years old, his death benefit of $1 million could be used to fund the $20 million policy on Judy’s life, effectively helping the family extend Judy’s policy and maintain its annual $68,000 premium.
If Judy dies first
If Judy dies before John, the full $20 million death benefit will go to the ILIT, and the family can determine if they’d like to continue funding John’s policy or surrender it for cash.
If you have a client similar to this, call Quantum at 800.440.1088 today to receive an actual case design. Today’s permanent life insurance policies have the potential to solve many different client challenges—from tax-advantaged wealth transfer, to tax-advantaged retirement income, to hybrid coverage for long-term care—so don’t hesitate to reach out to us to discuss your client’s situation!
As a life insurance consultant with more than two decades of experience, Chase works with advisors to build client relationships, develop strategies, and share product knowledge to help deliver a personalized and customizable experience.
