Policy Conversions & Ownership Transfers: All Things In Good Order

It was an eye-opener the first time I walked into the office of a civil engineer back in the 1970s and saw, spread across an entire wall, the flowchart mapping out the relationship and time sequence of all that was involved in getting an eight-story building there in the Burg from ground-breaking to grand-opening.

The complexity of the diagram was a mind boggle of boxes at several levels top to bottom, each containing a task that demanded completion before progression on the line to the next box was possible.

As we sit comfortably in the air-conditioned result of a similar building plan, the ease with which we can turn a tap or flip a switch seldom causes us to pause and think of all that got us there.

The order of things is essential.  The correct order is critical.  Fortunately the order and timing of insurance conversions and ownership transfers is less complicated.

A common planning scenario involves a personally-owned term policy where conversion is considered because of a decline in the health.  The goal is to transfer the policy to an irrevocable trust either to protect the death benefit from estate taxes, creditors or spendthrift heirs – or any combination of the three!

The issue at hand is whether to convert before or after the transfer of the policy to the trust

The answer will probably turn on the “best” fair market value for the contract.

Most advisors will probably choose to determine that the FMV of the term policy is its interpolated terminal reserve.  Level term products do have a reserve to offset the “underpayment” of premium in the later years when the insured is older, but the premiums remain the same.  On the other hand most advisors will determine that the FMV of the new permanent policy (in its first contract year) as premiums paid.  Usually the advisor will opt for the lower of the two.

If the policy is to be gifted to the trust the lower FMV could keep the gift within sum of the available annual exclusions (usually $14,000 per trust beneficiary) to avoid the need to file a gift tax return.

If the policy is to be sold to a grantor trust (to avoid the three-year look-back), the lower FMV will require that less cash be gifted to the trust to be used by the trustee to purchase the policy from the insured/grantor.

Call us when client planning involves the combined issues of policy conversion and ownership transfer.  We will assist in getting the information for determining the FMV of both policies and will assist legal and tax counsel with the information they need to properly order the transactions.

Back to the 70s – before the eight-story was completed I had gotten to know many of the workers at the job-site.  They complained that working construction was too much like Christmas Day.  They did all the work only to have some guy in a suit get all the credit.

Insurability – The Most Important Retirement Asset?

Few American publishers have had or will ever approach the influence of Henry Luce in his heyday.

Through the middle half of the 20th century, Luce founded and successfully grew a family of magazines whose content was a major factor in shaping the thought and activity of American society.

He named them after the three things he thought most important; Life, Time and Fortune.

We have only to look to our retirement planning to appreciate the accuracy his conclusion.

Consider This:

The purpose of a program of systematic savings during our employment years is to accumulate the Fortune necessary to provide for the Life to which we have grown accustomed hoping we have enough Time to achieve that goal.

Traditional qualified retirement plans can prove insufficient toward that end for wealthier clients.  Limits on contributions as well as an inadequate period for saving, especially in the event of premature death, can leave a retiree short of funds necessary to maintain his or her lifestyle.  Other initiatives must be taken.

A time-tested vehicle to provide supplemental retirement income is an over-funded universal life insurance policy.

Not only does the contract allow for additional income with many advantages similar to qualified arrangements, but the death benefit feature offers a “self-completion” aspect for the fund in the event of premature death.

Contact us today for a complete discussion of this planning concept.

Multiplication Tables – Using Basic Financial Underwriting To Increase Your Sale

How much does an insurance company think that your client is worth?  Many times it is much more than your client does, and you have their underwriting guidelines to prove it!

Insurance companies don’t want to over-insure someone.  Too much coverage can often result in someone falling down a flight of stairs before their proper time.  Carriers set their financial underwriting criteria to limit the amount of insurance someone can buy, not to try to increase the size of the sale.  So financial guidelines are a carrier’s attempt to standardize the process for determination of the reasonable worth of an applicant based on their situation.

The most common insurance need among prospects and clients is to replace the income survivors would have anticipated had premature death not occurred.

The starting point for calculating the amount of coverage a carrier will issue for purposes of income replacement is determined by a multiple of current annual compensation based on the proposed insured’s age.

The multiple deceases with age, understandably, because death denies a person fewer potential income-producing years as they get older.  Multiples vary from company to company.

Consider one of the more conservative examples:
Age Multiple
20-29 20-25
30-39 15-20
40-49 12-15
50-54 10-12
55-59 8-10
60-65 5-8
Over 65 2-5

The table can help a client to realistically focus on just how big a pool of money the survivors would need to survive over the remaining years should a wage-earner pass away.  And the client can “fatten up” a little in that the compensation figure used is usually the pre-tax earnings which in the calculation process translates into an amount of untaxed death proceeds.

Carriers will usually only take earned income into consideration unless it can be shown that the insured’s death might have a direct affect on unearned income.   Non-working spouses can usually get a minimum of one-half the coverage on a working spouse.

At young ages the calculation can result in a large death benefit.  But it is what the client needs and if he or she is healthy the competitiveness of current term insurance rates make sufficient coverage affordable to all.

Call with any questions concerning financial underwriting questions that may arise in case planning or when dealing with carriers.

Avoiding Collateral Damage

The term collateral damage was originally used during warfare when a military target was struck.  Even when the attack was successful it often left behind peripheral harmful results – usually affecting nearby innocent civilians.  The phrase is now more broadly used to describe negative unintended consequences of an attempt to do something beneficial.

Life insurance is often used as security on a loan, usually in a business situation.

Urgency of the circumstances (or poor advice) usually results in a creditor simply being added as beneficiary on the policy for the amount of the loan.  The result is a prime opportunity for collateral damage.  Parties to the loan or the policy seldom think to adjust the creditor’s beneficial interest as the loan is paid down or even paid off.  So if death occurs the creditor is unjustly enriched and the remaining beneficiaries are short-changed.  Or a creditor’s beneficial interest can be too easily changed or eliminated without his or her knowledge.

Here are the rules:

Rule #1 – Never secure a loan with a beneficiary designation.  Always use a collateral assignment!

A collateral assignment (C/A) is a formally documented lien on the policy in favor of the creditor who stands first in line for the share of the death benefit described by the terms of the C/A.  But there can be collateral damage from a collateral agreement if things are not done properly.  So . . .

Rule #2 – Use the carrier’s C/A form.

Rule #3 – Get the carrier’s permission before making any modifications on the C/A form

Rule #4 – To avoid the appearance of practicing law, only modify the C/A at the specific direction of the client or the client’s attorney.

Rule #5 – Make sure the C/A is dated after a time the policy is in force.

Rule #6 – Make sure the completed C/A is filled with the carrier, or the carrier won’t know to protect the rights of the creditor if benefits are paid.

Rule #7 – MEC Alert!  Make sure the client understands that if a C/A is filed on a modified endowment contract the amount secured by the C/A is reportable taxable income to the extent of gain in the contract (like a LIFO distribution).

For all its conceptual simplicity, the execution of a collateral assignment usually has many problems as different circumstances pop up with each case.  Call with any questions or for assistance with the drafting, approval and implementation of a collateral assignment.

Solving A Major “Minor” Problem

In the 2000 comedy flick Family Man, the investment guru played by Nicolas Cage is asked if he likes kids.  His response:  “On a case-by-case basis!”

But when minors are to be a party to a life insurance policy we can’t be so selective.

Every case is a potential problem and contracts must be implemented accordingly.

Minors are not legally competent (as in not allowed under the law) to own a policy or take possession of the death benefit, so… the easiest solution is to always use a state’s Uniform Transfer to Minors Act (UTMA) when drafting a beneficiary designation for a minor child.

A few basics:
  • The device is created in the beneficiary designation and operates like a “poor-person’s trust” when a separate formal trust is too expensive or too complicated to use.
  • A custodian-beneficiary is appointed to watch over the policy and proceeds for the benefit of the minor according to the directives in the state’s UTMA.
  • A successor custodian should always be appointed, since there is a good chance the custodian may pass away before the minor.
  • When the minor reaches the age of majority (which can differ with each state) the policy or proceeds must be turned over to him/her “lock, stock and barrel” – unlike a trust where control can be delayed well into adulthood.
  • The wording must comply with state law.  In addition, always check with the carrier Claims Department for its approval.
  • There must be a full and separate designation for each minor beneficiary.

The most important thing on a life insurance policy is the beneficiary designation.  But you’d never know it by the small amount of space given for it on the application – space that is especially inadequate if a minor is involved.  A UTMA designation will always take a separate page to be appended to the application.

You probably know that Cage’s real name is Nicolas Coppola.  He changed it for the screen because he didn’t want to appear to be cashing in on the reputation of his uncle, director Francis Ford Coppola.