Easy Ways to Turn Common Insurance Mistakes Into Tax-Free Wealth


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It’s frustrating. Year after year, our office is asked to give a second opinion on the completed estate plans of owners of family businesses. It is rare—very rare—to analyze the estate plan (particularly the life insurance policies) of a real-life client and find that all is as it should be. Typically, we find the wrong kind of insurance. Wrong ownership. Wrong beneficiaries. Wrong tax consequences. It goes on and on.

This is a big deal. We are talking big money. Typically, the IRS gets 50 cents to 55 cents out of every life insurance dollar. Imagine owning a $1 million policy, and the IRS gets $550,000 but your family gets only $450,000. It happens all the time. A needless tax travesty.

Let’s review the three biggest mistakes business owners make concerning life insurance.

Mistake #1: A corporation should never own insurance on the life of a shareholder, particularly a majority shareholder. Why?...The trouble starts as soon as the shareholder dies: The policy proceeds are subject to the claims of corporate creditors. Worse yet, if a C corporation, the proceeds can be subject to the alternative minimum tax (AMT)—which can steal up to 20 percent of the proceeds—and the net proceeds (after the AMT) can only get into the hands of your family by paying a second tax via a taxable dividend (OUCH!). If an S corporation, the proceeds (although not subject to the AMT) are still locked in the corporation and can only be paid out tax-free if all old C corporation surplus is first paid out as a dividend (a terrible and tax-expensive idea).

Mistake #2: The life insurance policy is owned by you or your spouse. Someday the policy proceeds will be included in your estate. You just guaranteed the IRS a big—unnecessary—payday.

Mistake #3: The policy (with cash surrender value) is old and the cash surrender value is half or more of the death benefit. You no longer have a life insurance policy but a lousy investment.

What should you do? Here are the typical recommendations we give to our clients so that, you and your family—instead of the IRS—win the insurance tax game. Mistake #1: Transfer the policy from the corporation to your name, paying the corporation only the amount of the cash surrender value (a tax-free transaction). Next, transfer the policy to a Wealth Creation Trust (an irrevocable life insurance trust that eliminates all income and estate taxes). Mistake #2: Transfer the policy to a Wealth Creation Trust.

Mistake #3: If you are insurable, dump the old policy and replace it with a new policy to be owned by a Wealth Creation Trust. First, if you are married, make sure that replacing the policy on your life is the right type of policy. About 80% of the time a second-to-die policy (insures you and your spouse) will give you significantly more bang for your insurance premium dollar. Second, determine how to reduce the premium cost: (1) if your company has a 401(k) or other qualified plan look into a “SUBTRUST.” The plan, not you, pays the premiums. Even your IRAs—traditional or rollover—can join in the premium-saving fun. (2) Whether you need single life (only you are insured) or second-to-die, check out “premium financing.” You don’t pay any premiums, nor do you pay interest, just the low fees to the bank to initiate and maintain the loan.

This article does not even begin to explore all of the economic possibilities and tax tricks that you should learn to win the insurance tax game. Also, there are exceptions and traps.

Here’s an easy way to get started: List the policies on your life and your spouse’s life, whether owned by you, your corporation, a trust or otherwise. Then ask this question about each policy: What is the ultimate tax cost—income and estate—while I’m alive?…When I die?...When my spouse dies? The answer should be ZERO. If not, do what is necessary to make the answer ZERO. This usually means implementing one or more of the recommendations listed above for each of the above mistakes.

Have a question?...Call Irv Blackman at (847) 674-5295. Or do you want to learn more about how to eliminate the estate tax and build your family’s wealth? Then browse my web site: www.taxsecretsofthewealthy.com. If you have professional advisors, ask them to look at the web site too. They’ll thank you.