Individuals in their 70’s and 80’s, who have spent decades accumulating assets typically have two types of goals.
- Sustaining, and if possible, enhancing their own cash flow to ensure that they can maintain their standard of living.
- Mitigating the effects of taxation from tax deferred assets, qualified assets, and other holdings thereby distributing greater wealth to their heirs.
While assisting one’s heirs is important, my practical experience has shown that providing for one’s self and immediate family takes precedence over providing for ones heirs.
Even if well intentioned individuals in their 70’s and 80’s desire to reduce taxes (including Estate Taxes), they all too often cannot or will not take advantage of life- insurance as part of their estate planning. Quite often, their rationale for not moving forward stems from the large premiums that are inherent with purchasing policies at these ages, and the natural aversion to mortality that life insurance suggests.
While there are a number of methods to mitigate these premiums, invariably successful employment of arbitrage has proven to be the most palatable and successful.
Intuitively, one would think that a “zero sum game” exists whereby enhancing one’s own standard of living would invariably reduce funds available for ones heirs. This is not universally the case. There exists a simple and very effective way for individuals to simultaneously enhance both their own cash flow and funds available for their heirs. This is accomplished by coupling the purchase of life insurance with an immediate annuity.
Although annuities are not appropriate for everyone, they have the potential to work remarkably well for individuals in their 70’s and 80’s in generating significantly higher returns than comparable investments. When annuities are coupled with life insurance, a “win-win” scenario can be created, with individuals and their heirs both receiving more money than they would have otherwise realized. The advantages of a life insurance-annuity tandem include:
- Generating additional current cash flow for individuals and their families to enjoy
- Enhancing the future value of assets left to heirs
- Mitigating taxes (including Estate, and Income taxes)
Structuring an effective life insurance-annuity tandem is a very straight forward process. The major hurdle involves underwriting. As individuals who have obtained life insurance can attest, there exists a wide variety in pricing and underwriting classes between different insurance carriers offering the same type of product. Today, many carriers are offering table shaving programs that will allow many formerly out of reach premiums to be priced in the more favorable standard rate classifications.
Given this wide range of pricing and underwriting options it follows that certain companies offer more attractively priced or underwritten life insurance policies, while other companies offer more attractively priced or underwritten annuities. It further follows that if life insurance policies and annuities are obtained in tandem, there may well exist pricing differentials that can be realized to one’s advantage. Hence the concept of Arbitrage which is defined as follows: noun; “the nearly simultaneous sale and purchase of products within different markets in order to profit from pricing differentials” By taking advantage of arbitrage opportunities that exist between different companies and coupling the purchase of life insurance with an annuity, individuals can realize significant economic upside.
To illustrate the power of this in -tandem technique, consider the following example;
- Healthy 79 year old male
- Three married children and six grandchildren
- Significant assets placing him within the higher Income and Estate tax brackets
- $1,000,000 in CD’s and or comparable instruments generating a 4% pre-tax return and a 3% after tax return, with the proceeds subsequently spent.
- Other liquid investments generating an 8% after tax return
- Interested in obtaining enhanced yields on investments without taking on additional risk
- Has an interest in providing for heirs, but unwilling to do so to the detriment of his own cash flow/standard of living
Status Quo. If no changes are made, this individuals CD’s would generate an after tax return of $30,000 per year, with ultimately $550,000 passing to his heirs.
Life Insurance- Annuity Tandem. As an alternative, rather than investing $1,000,000 in CD’s generating an after tax return of $30,000 this individual could:
- Invest in an immediate annuity, generating annual, guaranteed pre-taxed proceeds of $157,590 and after tax proceeds of $140,225 based on a 66.7% exclusion ratio and a 33% income tax rate.
- Purchase a $1,000,000 life insurance policy requiring an annual guaranteed premium of $55,270
Utilizing the technique of Arbitrage, he would more than double his annual after tax return during his lifetime from $30,000 to $84,985 ($140,225 less $55,270). Moreover, if he did not need the additional $44,985, he could re-invest these proceeds and ultimately provide additional funds for his heirs. If the excess funds were re-invested annually through life expectancy-12 years- and generated an after tax return of 8%, and additional $856,686 could be created. With the addition of one extra step, this individual could utilize part of his annual gifting allowance to eliminate transfer taxes and direct that the policy be owned by a trust to keep the proceeds from inclusion in his Estate. As a result, his initial $1,000,000 would grow to $1,853,686 thus nearly tripling the amount to his heirs.
Please note that this is an example of but one of several ways that life insurance and annuities can work in tandem.
Other examples can utilize second-to-die policies where couples are involved. The bottom line is that there are several ways for individuals in their 70’s and 80’s to structure a “win-win” scenario to benefit both themselves, and their heirs by taking advantage of insurance arbitrage opportunities.
In addition to the above mentioned uses for arbitrage based planning there are two other very active an important arenas that clients may wish to look into. These areas are IRA Wealth Transfer (how to pass your IRA to your heirs with tax free dollars), and Charitable Giving (creating current income for your charity now while you are living, and leaving an endowment at your death).
Winston P. Stevenson is the Principle of W. P. Stevenson and Companies. W. P. Stevenson and Companies is an independent firm aiding clients with insurance, wealth accumulation, and wealth transfer strategies.
Special Thanks are extended to all those that have contributed to the practical content of this article and the day to day implementation of the strategies described herein. |
