Last month, we talked about how cash value is influenced by the different cash value investment options, the historical performance of such cash value investment options, and cost-effectiveness of the various cash value allocation options.

This month we talk about using the most advantageous and consistent rate of return. There are different ways that companies publish rates of return depending on the type of life insurance.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of cash valuation in Advisor’s Journal, see Historical Performance of Underlying Cash Value of Life Insurance (CC 11-82).

Last month Advanced Market expert Barry Flagg talked about the relevance of policy cash values to the overall suitability of a permanent life insurance policy. This month he addresses how cash value is generally influenced by the number of cash value investment options, the historical performance of such cash value investment options, and the cost-effectiveness of the various cash value allocation options.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of valuation in Advisor’s Journal, see Life Insurance Valuation (CC 10-09).

Barry Flagg continues his popular series, this month discussing the cash value of life insurance as a factor of suitability. The suitability of a permanent life insurance product is influenced by the degree of cash value liquidity throughout the life of the policy. All other factors being equal, the higher the liquid cash value after deduction of cost of insurance charges and policy expenses (including contingent surrender charges), the more suitable the policy.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For in-depth analysis of income taxation of life insurance, see Advisor’s Main Library: D–Gain Or Loss On Surrender Or Sale

Life insurance policies are granted preferred tax treatment, with death benefits distributable tax-free to beneficiaries, but some distributions from a life insurance policy are subject to income tax. For instance, although inside buildup of policy value occurs tax-free, when that value is tapped through policy withdrawals, the policy owner may be taxed on the distribution. Current income taxation can also result when a policy is cancelled or otherwise terminated when a policy loan is outstanding, as illustrated by a recent Tax Court case.

For previous coverage of life insurance developments in Advisor’s Journal, see Life Insurance: Iron-Clad Asset Protection or Chink in the Armor? (CC 10-114) and IRS Blesses Life Insurance Policy Held by Profit-Sharing Plan (CC 10-96).  Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For in-depth analysis of policy loans and withdrawals, see Advisor’s Main Library: Section 19.1 G—Tax Treatment Of Policy Loan Interest and Section 19.1 C—Taxation of Amounts Payable During Life.

We invite your questions and comments by posting them below or by calling the Panel of Experts.

Why is this Topic Important to Wealth Managers?   Discusses estate tax considerations in regards to life insurance policies.  Also, includes a detailed dialogue of the incidents of ownership concept. 

What do most wealth managers try to avoid when planning with life insurance and trusts?

That the Gross Estate for Estate Tax calculations would include the death benefit from the policy in the estate.[1]

What are some common ways to avoid this dilemma when using a trust and life insurance in regards to estate planning?[2]

The insured should never own the policy; “it should be owned from inception” by the trust or third party. 

• A trustee takes “all the actions to purchase the policy on the life of the insured”. 
• The trustee should be “authorized but not required to purchase insurance on the life of anyone whose life the trust’s beneficiaries have an insurable interest.”
• The trust explicitly prohibits the insured from obtaining any interest whatsoever that the trust may purchase on the insured’s life. 
• The trust does not require, but rather permits the premium payments.
• Trust is well funded, beyond that of one year of premium payments. 
• The trustee acts in the best interest of the beneficiaries. 

A revisionary interest will give rise to incidence of ownership [3], which could include the insured’s right to; [4] 

• Cancel, assign or surrender the policy.
• Obtain a loan on the cash value of the policy or pledge the policy as collateral for a loan. 
• Change the beneficiary, change contingent beneficiaries, change beneficiaries share of the proceeds.

When discussing incidents of ownership, naturally the 3 year rule should be further expounded.[5] “The 3-year ‘bring-back’ rule” is applicable, “with respect to dispositions of retained interests in property which otherwise would have been includable in the gross estate”.[6]  As discussed in AUS Main Libraries Section 8, C—Lifetime Gifts Of Insurance And Annuities-“Gifts Within Three Years Of Death”, essentially, the rule as it applies to life insurance means that any policy transferred out of the estate of the insured within 3 years of his/her death, the policy proceeds are brought back into the gross estate for estate tax calculations. 

It is generally accepted that “the trust should be established first, with a transfer of cash from the grantor to be used to pay the initial premium” or a few years of premiums.  “The trustee would then submit the formal application, with the trust as the original applicant and owner.”  Generally, the insured will “participate only to the extent of executing required health questionnaires and submitting to any required physical examination.”  Again the key is that the, “grantor/insured not have possessed at any time anything that might be deemed an incident of ownership with respect to the policy.” [7]

Tomorrow’s blogticle will discuss planning ideas related to life insurance, trusts, and estate planning.     

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] Life Insurance Planning 4^th Edition (2007).  346-347. Leimberg and Doyle. The National Underwriter Company. 

[3] 26 U.S.C. § 2042 (2). 

[4] Life Insurance Planning at 351. 

[5] 26 U.S.C. § 2035 (d). 

[6]AUS Main Libraries, Section 8. Lifetime Gifts, C—Lifetime Gifts Of Insurance And Annuities, Subsection 6. Insurance Gifts Within Three Years Of Death.  Last Accessed 9/17/2010. 

[7] Id. citing, In Estate of Joseph Leder, 893 F.2d 237 (10th Cir. 1989), Internal Revenue Service, Actions On Decisions 1991-012.

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