Term Insurance or Permanent Insurance?

Hoffman19Many of our clients wrestle with the decision to purchase term insurance or permanent insurance.  The premiums for term insurance are cheap, particularly when you’re young, while permanent insurance generally provides a level premium with more certainty that a death benefit will be paid.

Term insurance seldom pays a death benefit.  The reasons for this are simple.  Most people live to, or close to their life expectancy.  By the time they have reached their life expectancy, the premiums on term insurance have increased to the point where the insurance is dropped, or the individual has reached an age or health condition that is deemed uninsurable by the insurance company.

For this reason, term life insurance is best for temporary needs such as support for a surviving family (particularly when you are young), funding a buy/sell arrangement for a closely held business, providing cash (key man insurance) for transition of business, and for the repayment of debts.

I often tell clients to load up on term insurance when they are young, partly because it’s so cheap, and partly because their financial “security” needs are so great when their families are young.  Of course, the premiums for term insurance are lower because it seldom pays a death benefit.  The only usual financial “winners” for term insurance are the insurance agent and the insurance company.

As we get older, financial obligations (except retirement) tend to decrease.  Many of us begin to look at permanent insurance as a permanent feature or category of assets that we are accumulating during our lifetime.  Most of us want to have a certain portion of our insurance that is ongoing.  The insurance can provide liquidity to our heirs, cash to pay estate taxes, a fund to provide for the maintenance of a second home, or a mechanism to equalize the estate where certain hard assets (such as farm, business or vacation home) is necessarily directed to one particular heir, while the other child receives cash.

Permanent insurance generally falls into three categories: whole life, universal life (including universal blends and indexed products) and variable life.  Whole life is the most expensive, while universal life is generally the most inexpensive permanent insurance policy.  Variable life has more stock market investment features inside an insurance policy wrapper.

Universal life is popular among our clients as it provides guaranteed lifetime coverage at the lowest level of permanent insurance premiums, and generally level premiums can be pre-paid or lowered by lump-sum or higher premiums in early years.  Generally, with universal life policies, guaranteed cash accumulation for retirement income or other purposes is not a significant objective.  The goal is to lock in a death benefit while keeping premiums as low as possible.

By far, our estate planning clients buy mostly universal life products.  While there are many varieties, studies show that the internal rate of return on universal life products is generally positive, where as the internal rate return on any term policy, if clients live to or close to their life expectancy, is significantly negative.  In other words, with term insurance, we have thrown our money away unless we die prematurely.

Most term insurance lapses before death.  This is fine if the reason for the insurance no longer exists.  However, many policy owners want to extend the coverage of their insurance while their health is still good, because they know that the risk of their health changing increases with age and health changes can happen suddenly.

Be aware that term policies can carry a conversion right.  This is important, even though it might marginally increase the premium cost, because a client might otherwise become higher risk or uninsurable prior to the expiration of the term policy and be unable to get other insurance.

Generally, our clients are rarely content to allow their insurance policies to lapse when they reach the end of the coverage period.  The older we get, the more we see the value of “investing” in insurance as one of our many buckets of asset categories that we are accumulating and tending to during life.

For more information regarding this or any other estate planning concern, please visit the Hoffman & Associates website at www.hoffmanestatelaw.com, call us at 404-255-7400 or send us an email.

SELF-CANCELING INSTALLMENT NOTE (SCIN)

The Self-Canceling Installment Note (“SCIN”) is a planning technique usually used in a sale of an asset to either a trust or directly from an older family member to a member or members of a younger generation.  Basically, the older generation sells the asset in exchange for an installment note with a term shorter than the seller’s life expectancy, which is found in Internal Revenue Service (IRS) Tables.  The SCIN is a valuable tool because, if the seller dies before the term of the note, the remaining balance is completely canceled and is not included in the seller’s estate.

The SCIN is best structured as requiring interest-only annual payments until a balloon principal payment is due at the end of the term.  By deferring the principal payment until the end of the term, the amount canceled upon death will include the entire principal amount of the promissory note.

Of course, the IRS would not allow this transaction without a modification of the terms of the note to make it an arms-length transaction between the parties.   So, either the principal amount or the interest rate must be increased to make this a bona fide transaction.  The older the seller is, the greater the mortality risk premium will be.  However, with long-term interest rates being at historical lows right now, the time has never been better for an estate-freezing transaction using a SCIN.

For example, using October’s rates, a 55-year-old person could sell assets using a 28-year SCIN with a balloon payment and an interest rate of only 2.695%.   If the seller died before the end of the term, the value of the entire principal amount would be transferred to the trust without incurring any estate tax.

These low rates make a SCIN not only a good idea for clients looking to freeze some of the value of their estates, but there is also opportunity for clients who have already entered into DGT sales (see other articles on website that describe DGT sales as a popular estate planning/freezing technique) to refinance with a SCIN, possibly at lower rates and the self-canceling feature.

 

For more information regarding estate planning, business law or tax controversy and compliance, please visit the Hoffman & Associates website at www.hoffmanestatelaw.com or call us at 404-255-7400.

 

In accordance with IRS Circular 230, this article is not to be considered a “covered opinion” or other written tax advice and should not be relied upon for IRS audit, tax dispute, or any other purpose.  The information contained herein is provided “as is” for general guidance on matters of interest only.  Hoffman & Associates, Attorneys-at-Law, LLC is not herein engaged in rendering legal, accounting, tax, or other professional advice and services.  Before making any decision or taking any action, you should consult a competent professional advisor.