Don’t Miss Out

Unlock millions by dropping life insurance “baggage”

Irecently met with a successful family in the process of developing a succession plan to transition wealth to the second and third generations. I presented three potential scenarios following an estate freeze:

1. Use cash on hand to pay the tax bill on death

2. Use life insurance to pay the tax bill on death

3. Donate frozen private company preferred shares on death and use life insurance donation to buy them back

The numbers were crystal clear. No life insurance resulted in significant estate erosion. Life insurance to pay taxes left the family $12 million ahead. Donating shares created a $33-million family foundation, left more money for the family compared to doing nothing, and turned taxes into charity. Despite this, the family chose to stay the course and use cash to pay taxes. They missed an opportunity to expand their legacy by creating a transformational gift to a family foundation. Why?

LIFE INSURANCE OFTEN COMES WITH “BAGGAGE”

This isn’t the only ultra-high-net-worth family to resist using life insurance strategically. I’ve learned that in most cases what holds people back is baggage.

Many people view life insurance as a grudge purchase, only needed while building wealth to pay off the family home mortgage, replace income to support day-to-day expenses, and provide for kids’ education. It’s like home and car insurance — a necessary but resented expense. Others had a negative experience with an advisor or a different type of insurance, or they know someone who made a travel, property, or auto claim that an insurance company denied. They don’t realize life insurance is different, and it’s hard to argue with a death certificate and built-in guarantees.

Whatever the reason, successful families need to drop the baggage and consider these six reasons to use life insurance:

• Estate tax funding

• Estate equalization for children in and out of the business and for blended families

• Shareholder agreement funding

• Key person coverage

• Tax-exempt asset diversification using corporate-owned insurance and the capital dividend account (CDA)

• Philanthropy

Life insurance is a powerful tool to optimize or preserve family wealth at a low cost with high tax efficiency. It can be a multiplier of wealth and philanthropy. Think of it as switching out your putter for a driver to amplify the effect of your golf swing and make your ball go farthest.

Illustrating The Multiplier Effect

The Cooper family (name changed) lives in Ontario and previously executed an estate freeze, which froze the value of the parents’ preferred shares at $62,400,000. Half that amount will be taxed as a capital gain on death and result in a tax bill of $16,692,000 (tax rate of 53.5%). There are three ways to handle the tax liability.

SCENARIO 1: Pay the tax bill in cash saved up for this purpose — a significant sum to tie up for an uncertain number of years. This is the “no planning” scenario. Heirs will receive $45,708,000.

SCENARIO 2: Buy just enough life insurance to cover the tax bill. For illustration purposes, a joint last-to-die level-premium universal life policy with a death benefit of $16,692,000 will cost them $509,974 annually. Assuming the second spouse dies 21 years from now, at age 90, the cost of insurance will amount to $10,709,454. With this option, the estate will pay the same amount of tax to the government, but the cost to the family is about $6 million less. In addition, the next generation will be able to use the resulting $12,665,521 capital dividend account (CDA) credit to withdraw cash from the company taxfree — a $6-million tax savings for the next generation by using the insurance CDA credit (assuming a 47.74% tax rate). Heirs will receive $57,737,074.

SCENARIO 3: Most people know about donating non-registered appreciated public securities such as stocks, exchangetraded funds, mutual funds, and seg funds in-kind and paying no capital gains tax. Few know you can donate private company preferred “frozen” shares. This family can donate their private company shares to charity on death and use life insurance of $33 million to fund the generous donation and redeem the shares for the family. This transforms tax into charity. Heirs will receive $53,084,486.

FAMILY, CHARITY, OR TAX DEPARTMENT?

When we die, our money will go to some combination of family, charity, and the tax department. Appropriate planning directs more to family and/or charity — and can even, as in scenario 3, take the tax department out of the equation.

This type of planning is easily scaled up or down and applies to high-net-worth and ultra-high-net-worth families alike. Baggage aside, it’s critical to objectively look at the numbers — they speak for themselves.

MARK HALPERN, CFP, TEP, MFA-P, is CEO of WEALTHinsurance.com and has developed the Power of PlatinumTM program with Jim Ruta to train, coach, and mentor insurance and investment advisors. Connect with him on LinkedIn, where he shares case studies and success stories.

BY JASON MCMAHON