Creating the successful estate plan: a combined effort of several qualified professionals
By Christopher P. Hill, RFC
Wealth and Income Group LLC and FuneralResources.com
Estate planning often fails to protect your family, and simply creating a will or trust leaves many key problems unsolved.
What is estate planning?
Insurance companies, banks, financial advisers and many attorneys advertise that they will help you with your estate plan. However, unless financial advisers are using the proper disclosures when talking about estate planning, many people can become confused as to whether you are providing financial and/or legal advice.
An effective estate plan is one that protects and provides for you and your loved ones, both now and in the future. The plan distributes your property the way you want, when you want and how you want, while paying the minimum of taxes and expenses, and hopefully causing the least possibility of a family feud. The reality is the only way this effective plan can happen is when two things occur:
1. You take advantage of utilizing the skills of lawyers, accountants, financial planners, insurance professionals and/or trust officers.
2. Each of the financial professionals involved work together to coordinate and integrate this estate plan so that it works in harmony with the rest of this client’s comprehensive financial plan.
Sam and Sally meet with a seasoned estate planning attorney to develop an estate plan. During the interview, the estate planning attorney discovers that Sam has several old life insurance policies which would provide $300,000 to Sally if Sam died, and the total cash value of the policies is $280,000. The cash value is what the insurance company would pay Sam today if he turned in (surrendered) the insurance policies while he's still alive.
Like many seniors and baby boomers, Sam draws income from a pension plan which has a 50 percent survivor benefit. Therefore, after Sam dies, Sally will receive only half of his pension income, which creates a significant decrease in not only Sally’s income and standard of living, but also in her ability to maintain the payments and upkeep of their house.
Like most seniors and baby boomers (and homeowners for the most part), Sally’s home is her pride and joy. She has spent thousands of hours on activities and improvements such as landscaping, decorating her kitchen, adding a wonderful deck and patio and so on. Sally enjoyed making her home a very pleasing and comfortable place, and this special home is filled with many wonderful memories of family gatherings. What is the central problem?
As mentioned earlier, lawyers can create the wills, trusts, powers of attorney and property transfers to make the estate plan perform in a way that they believe will be effective. But, the reality in most cases is that these documents do not save Sally’s house. The central problem in Sam and Sally’s estate is not the legal documents.
Their original intention was to prepare the proper legal documents and an estate plan that would ensure their property goes to whom they want, when they want and how they want, with the minimum of taxes and expenses. However, in this case, this does not accomplish some key goals which have been overlooked or ignored.
The problem here is that Sally, who statistically is likely to survive Sam, will not receive enough in life insurance proceeds to replace the income she needs in order to stay in her beloved home after Sam dies. As with most cases, Sam and Sally's children have their own families, are well established and don’t need, (or are not depending on) Sam and Sally’s money to live on. And now at Sally’s age, the so-called “golden years”, she does not have the stamina, skills or desire to go back into the workplace.
Providing for the surviving spouse
In this case, the proper solution to this central problem would be for Sam, or a qualified financial adviser, to identify this potential problem, and exchange his insurance policies for a new insurance policy that will provide enough money for Sally to live on after Sam dies.
Not only is this something financial advisers are trained to protect retirees against, but they are also likely to know that the tax code under Section 1035 allows Sam to exchange his old policies for a new policy with a higher death benefit and lower cash value. The best part is the life insurance policy exchange can occur without paying any taxes at the time of the exchange, even though Sam is using his untaxed earnings (capital gains, dividends, interest, etc.) in his insurance policy to buy something of greater value to him.
The main purpose of life insurance
There are many reasons people or families choose to buy permanent life insurance, and it can serve many purposes. For example, some purchase these policies as an investment, due to the upside growth potential of the cash value. Others purchase these permanent policies as a tax-saving or tax-deferral vehicle, since the cash value grows without being taxed, and if managed properly, can be withdrawn without paying taxes or penalties. One other common use of permanent insurance is to replace income or estate taxes. However, the basic definition of insurance is the transfer of risk. Therefore, the most common reason people own life insurance is to replace the income lost in the event a spouse were to unexpectedly die, transferring the risk of a premature death to the insurance company. In this case, with $280,000 of cash value and a death benefit of $300,000, Sam has nearly all of the risk of his death on his shoulders,and his insurance is providing him virtually no leverage.
This is the type of information that should be discovered by a financial adviser or insurance agent in the initial stages of the planning process, or discovered and brought to Sam and Sally’s attention during a review of their estate plan. By simply asking questions regarding the amount of income Sally will have to live on should Sam die, how much life insurance Sam has, what kind of life insurance Sam owns,and what the cash value amount is, this potential problem could be easily avoided.
Solving the central problem
The best possible solution is for Sam and Sally to have a qualified estate planning attorney and trustworthy financial and/or insurance professional working together. The insurance professional’s role would be to “shop around” and locate an insurance company that would be willing to offer Sam the best and most appropriate policy, with the goal being the largest death benefit and the longest duration. Sam and Sally would then pay for this life insurance policy by using the cash value from Sam’s existing insurance policies.
The features and benefits
This aforementioned life insurance policy exchange, known as a 1035 exchange, does not require Sam and Sally to write a check, there are no tax consequences when they “trade the cash value” for this new policy,and they will not be required to pay any future insurance payments because they used the entire cash value to pay for this new policy in a lump-sum.
So,if Sam owns a permanent policy, this is better in every way. If Sam owns a policy where the life insurance protection only lasts for a certain number of years — commonly referred to as either term insurance or universal life insurance — Sally will likely receive a much high amount of life insurance proceeds, and when combined with some of their other assets and income sources, this will likely be enough for Sally to stay in her beloved home. Of course, Sam had the alternative of taking the $280,000 out of the policy and investing it in hopes that he could grow this $280,000 to a much higher amount, but there are two major problems with this strategy. First, there is risk. For example, in 1966, the Dow Jones Industrial Average (DJIA) reached 1000 for the first time. However, approximately eight years later, the DJIA plummeted to 570 at the Watergate Bottom, losing nearly 50 percent of its value during this eight-year period. Another example is back in 1999, when the Nasdaq surged to approximately 5000. However, 10 years later, the Nasdaq was below 1000, losing 80 percent of its value over this 10-year period. The second problem is, even in a rising stock market trend such as 1990 to 1999, there are no guarantees Sam will live to a certain age.
How can this fail?
This happens very frequently because Sam’s prior insurance agent failed to discuss the possibility of this future problem with Sam and Sally. However, if Sam had consulted with a qualified insurance agent or financial advisor, he or she would have likely recognized this problem and either suggested a solution or recommended that Sam and Sally perform annual reviews to monitor this problem in the years ahead. This happens far too often in the financial professional industry, and the most common reasons are:
1. Some financial professionals tend to focus solely on products or strategies where they are compensated
2. Others fail to recognize the importance and necessity of coordinating with the other key financial professionals who are directly or indirectly involved
3. Some financial professionals lack the training and expertise to understand these issues and options.
Arguably the key ingredient in creating an effective estate plan is working together with a team of financial professionals who are looking out for the client’s best interest from a big picture standpoint. Working with a team that includes key financial professionals like a CPA, estate planning attorney, insurance professional, financial adviser or personal banker, allows each of them to make an important contribution in helping to protect and preserve an sound estate plan.