Are You Losing 30% of Your Life Insurance Premiums?

Life insurance is a tax-advantaged investment.

Life insurance is a tax-advantaged investment. Wealthy people buy it as an investment. Why? Because the death benefit (which is always greater than the premium paid) is free of income tax according to the Internal Revenue Code. Best of all, if properly done, (and it’s easy to do) the death benefit escapes the estate tax. It’s a simple fact: The tax law creates a tax-free environment for life insurance.

Buying life insurance leads the parade as the best method to legally conquer that horrible estate tax burden. Here’s a typical real-life example from our client files: Joe and Mary bought a $3 million second-to-die life insurance policy, which was owned by an irrevocable life insurance trust (ILIT). After paying $1,020,590 in premiums ($30,927 per year) for 33 years, Mary (Joe died five years earlier) was the second to die. The ILIT received the $3 million death benefit. Now the good part: the entire profit, almost $2 million, ($3 million less the $1,020,590 premium paid) was income tax free. The ILIT protected every dollar of the $3 million from the estate tax.

As estate tax planners, our experience involving insurance is a two-edged sword. The good edge contains the terrific tax-free benefits—no income tax, no estate tax—as outlined above.

But let’s face it, the blasted stuff costs money. That’s the other side of the sword—the bad side: You must pay premiums. Fair enough: You pay first to get the benefit later. The raw fact is that 70% of the time, on average, the policies cost 30% more (higher premiums) than they should have cost.

How do we know? Well, one of our basic tasks for every client for whom we do an estate plan is to have an insurance expert analyze the client’s existing insurance policies. We find that 70% of the time, an insurance consultant is able to find an equal to, or better quality insurance carrier, saving the policy owner 30% or more in premiums on an annual basis. Or, for the same premium outlay, he is able to increase the insurance death benefit by 30% or more.

Over the years, we have seen hundreds of examples of well-meaning insurance consultants recommending the wrong insurance products. Sad but true. Often, the product is too expensive for the client’s needs, or (this is the most common) the coverage is not changed or updated when the existing policy becomes obsolete or the client’s insurance needs have changed.

Our files are bulging with examples. Following are three common mistakes that we see over and over again.

Example #1. Jim, age 37, was paying $31,430 for a $3 million death benefit. What was his mistake? Over-paying the early premiums so premiums would stop after a period of time (15 more years for Jim). Here are the two rules you should burn into your mind: 1) If you intend to keep the policy to the day you die, the best deal is to pay premiums every year until you go to heaven. 2)If the need for insurance is temporary (i.e. until the kids grow up, pay off debt) then buy term insurance. Jim’s new premium is only $14,982 for his new $3 million universal life policy. He actually traded his old policy for the new one, which was a tax-free transaction.

A side note: If one or more of your policies is paid up (you don’t have to pay any more cash premiums) you are shooting yourself in the foot. Provided you’re still healthy, your current policy can be traded up (tax-free) for a larger death benefit without any further cash premiums.

Example #2. Joe, age 50, owned a policy with a $1.5 million death benefit, while paying a $14,941 premium per year (to be paid until age 100). The policy was purchased back in 1993 and had a cash surrender value of $246,786. Joe’s mistake (which was really his insurance agent’s mistake)? Not checking the insurance market every two or three years to see what was new and available. We arranged for Joe to trade his old policy for a $2 million death benefit ($500,000 increase) policy and future premiums of only $9,097 (also payable to age 100, but $5,844 per year less than the old policy). The rule to remember: As long as you stay healthy, have your insurance portfolio reviewed at least every three years.

Example #3. Jack, age 61 and married to Mary, age 60, had a portfolio of policies on his life, and all owned by an ILIT, totaling $13.8 million. Most of the policies were 15 years old or older. Premiums were $147,958 per year. The cash surrender value (CSV) was $1.5 million. Jack’s mistake—we see it all the time—was that he no longer needed single life insurance. Only second-to-die coverage made sense. Jack and Mary’s three kids were grown, had their own kids, and two of them were working in Jack’s business. There was one nonbusiness kid. Jack’s wealth had grown to over $46 million. He needed more insurance.

A side note: Substitute your own numbers. I am always amazed how many business owners or retired business owners are in the same boat as Jack.

Jack’s new insurance plan actually has two parts:

1) The $1.5 million of CSV in the ILIT (after the old policies were terminated) was invested. A portion was invested in life settlements (LS). A small public company that sells on the NASDAQ sponsors a LS program that earns (based on a historical average over 16 years) 15.83% per year.

2) Jack has $ 3 million in a rollover IRA. We used a strategy called a “Retirement Plan Rescue” (RPR), which allowed us to purchase new second-to-die coverage on Jack and Mary for $23 million. (Which demonstrates another common mistake: When the funds are not needed to maintain your lifestyle, not using—all or a portion—of qualified plan funds to pay your life insurance premiums.)

These examples are just the tip of the iceberg. If you think you may be overpaying, take a shot at having you insurance portfolio reviewed by an expert—you might just save 30%.