In recent years, clients have been confronted with significant challenges, including sustained economic uncertainty, tax law changes and volatility in financial markets. Maintaining client focus on the importance of estate planning has been a challenge for many advisors. Traditional estate-planning models focused on minimizing estate erosion due to estimated estate and gift taxes, but with the re-unified federal gift and estate tax exemption of $5 million, indexed for inflation, many clients assume they no longer need a wealth transfer plan. Considering the market and mindset shifts, advisors should suggest to their clients that they re-examine even the best laid-out estate plans and work with their clients to incorporate building a legacy.
The heart of legacy planning is the notion that clients can have a lasting and positive financial impact on the lives of heirs. Although the planning environment has changed, a client’s desire for the benefits of a legacy plan likely hasn’t. For a legacy plan to ultimately succeed, however, clients need to implement a strategy to define and stabilize the size of the legacy that will pass to heirs. To accomplish that goal, a common approach is to leverage gifts to the next generation with the purchase of life insurance.
A new tool in the implementation of a legacy plan involves using a projected inheritance. It will allow a grandparent to retain control of assets, gift premium dollars to secure coverage on the next generation and lock in a legacy plan that benefits both their children and grandchildren. This approach is valuable with all client age profiles, but as we’ll see, it resonates especially well with uninsurable clients.
Benefits Spanning Generations
Legacy planning involves multiple generations, typically grandparents planning for their adult children and grandchildren. When a grandparent implements an effective single-generation wealth transfer plan, there’s no guarantee that the adult children inheriting the wealth will do the same responsible planning for the grandchildren. Simply put, single-generation planning results in single-generation benefits. Grandparents question what, if any, legacy plan will exist to protect the family’s future generations unless they take on that task themselves.
A multigenerational plan reassures clients that their legacies won’t just survive, but will thrive. Using a projected inheritance to establish that legacy plan with life insurance carries significant benefits across generations. It’s important to note the roles of each generation to appreciate the dynamics:
• Generation 1 (G1) is the person who, on his death, is planning to transfer assets to the proposed insured’s estate. G1 is typically the grandparent.
• Generation 2 (G2) represents G1’s heir, or the proposed insured. G2 is usually G1’s adult child.
• Generation 3 (G3) is the ultimate beneficiary of any death benefit proceeds on the death of G2. G3 is typically the grandchild.
The use of a projected inheritance in the planning strategy carries benefits across all three generations.
Clients typically wish to maintain control over their assets in a wealth transfer plan if at all possible, particularly at older ages. When using a projected inheritance in a legacy plan, G1 may retain control of his assets while still having those same assets financially justify the life insurance coverage on G2. From G2’s perspective, he knows there will be a significant need for additional life insurance on inheriting G1’s assets, but doesn’t know what health he’ll be in when that inheritance occurs. When he seeks coverage later, it may be much more expensive than it otherwise would be today. A legacy plan using a projected inheritance will allow G2’s insurability to be locked in today and, potentially, give G2 access to policy cash surrender values throughout life. Finally, G3 benefits by having a legacy plan locked in place that provides both potentially attractive internal rates of return (IRRs) and liquidity from the life insurance death benefit when it’s needed. (See “Projected Inheritance Benefits,” this page.)
In the process of locking in a legacy plan, clients and financial professionals often run into a basic life insurance financial underwriting hurdle, whether in a personal, business or charitable setting. Generally, the amount of coverage being applied for must be financially justified based on an existing client need at that moment in time. Often, however, life insurance coverage is sought prior to the actual need arising and, while anticipating needs is encouraged, the amount of coverage still must be financially justified.
Now, consider a typical multigenerational planning case in which G1 plans to purchase life insurance on the life of G2 for the benefit of G3. Without sufficient G2 net worth to financially justify the coverage, implementation of the plan wouldn’t be possible. A creative strategy to address this issue is to use a proposed insured’s projected inheritance to justify the amount of coverage applied for. Note that this approach is possible with certain life insurance carriers that have established projected inheritance guidelines. Advisors should be aware of those guidelines to proactively incorporate them into planning strategies.
Generations of Opportunities
Legacy planning opportunities using a projected inheritance exist with a number of different types of clients. Advisors should raise the opportunity with the following client profiles:
1. G1 uninsurable clients. First and foremost, advisors should bring the projected inheritance strategy to the attention of uninsurable G1 clients. Advisors may have worked with elderly clients who were unable to secure needed life insurance due to medical issues. In some cases, years may have been spent developing the client relationship to reach the decision to purchase life insurance, only to discover that the client is uninsurable. That relationship may have been closed until now. Advisors may re-engage those clients and discuss a strategy involving the lives of their heirs.
2. G1/G2 multigenerational planning-inclined clients. Another opportunity exists with those elderly, insurable G1 clients who not only need life insurance for their own planning purposes, but also want to plan beyond the next generation by purchasing an additional policy on the life of an heir.
3. G2 clients expecting an inheritance. A third opportunity involves those G2 clients expecting a significant inheritance in the upcoming years, at which time they’ll have an even greater need for life insurance. They would like to purchase the appropriate amount of coverage for that future need today but can’t financially justify the amount based on their current net worth. In addition, they don’t have the liquidity to pay for the premiums, even if they could justify the coverage. Advisors should raise the projected inheritance strategy as a means to save those cases and extend the conversation to G1 to see what planning is in place for their needs. G1 would also need to be part of the planning discussions because liquidity is needed to fund the premiums.
Legacy Building Tools
There are three tools that join together in an effective multigenerational plan:
1. Projected inheritance strategies. This is the ability to secure coverage on a proposed insured who may not be financially justified for the amount of coverage he’s seeking. As noted, the key to moving a multigenerational plan forward is to leverage G1’s assets, using them to financially justify the life insurance purchased on G2’s life. The death benefit amount is justified based on financial underwriting of G2’s current net worth, combined with his projected inheritance. With this tool in place, G1 can secure a true legacy plan by locking in the insurability of G2 today. Having the assets of one generation justify life insurance coverage on the next is a new and valuable perspective, but carriers may have differing guidelines, so it’s important for advisors to identify exactly what a carrier will use. At least one carrier has defined guidelines requiring the following:
• G1 must be at least age 70 or have evidence of a life expectancy less than five years.
• Confirmation of an established estate plan that involves transfer of assets to the proposed insured. This proof can be in the form of either a copy of an executed irrevocable trust, a copy of the parent’s or transferor’s will and estate-planning documentation or an attorney’s written confirmation of the estate plan details.
• Verification of net worth of both the proposed insured and the transferors.
Lastly, an appreciation factor may be considered subject to review of the inheritance plan and asset characteristics. Be sure to check with carriers to verify their specific guidelines, as they may be modified.
2. Strong product portfolio. No plan is complete unless the appropriate product is selected. The right product suite for an effective legacy plan may include a variety of features, such as competitive death benefit protection, cash value potential, the ability to skip premium payments, attractive IRRs, flexible riders, diverse options with respect to how premiums are allocated for the potential of cash value accumulation and solid financial strength. There are special considerations when managing the product selection process across generations because needs and planning goals will likely differ.
G1 clients, generally those ages 70 and older, may be more risk-averse and desire a cost-effective death benefit cash value product, rather than one that focuses on cash accumulation. However, there’s a longer planning horizon when discussing the appropriate product for G2, G1’s heir who’s projected to inherit significant assets in the near future. For G2, there would likely be a greater desire for an accumulation product and access to cash values, while still providing a significant death benefit.
3. Transfer tax plan. Advisors have many opportunities to take advantage of the current transfer tax tools. In implementing a legacy plan using a projected inheritance, a premium payment plan will need to be identified.
Clients’ options include gifting their full exemption or any lesser amount. Those gifts reduce the size of the taxable estate and may be used to purchase and fund life insurance as part of the legacy plan. Using gift exemptions is especially important because G2 often lacks the funds to pay for the coverage. Depending on when the legacy plan funding is carried out, the size of the gift tax exemption may vary, and more planning may be needed to address situations in which it’s insufficient for policy funding purposes. In those situations, other options, such as intra-family private financing, should be explored.
The legacy planning tools come together to create significant benefits in a multigenerational planning case example. John, a 75-year-old G1 client, has a
$10 million net worth and is engaged in developing and implementing a wealth transfer strategy that creates liquidity and protects his assets from serious depletion on his death. He plans to purchase a life insurance policy in an irrevocable life insurance trust (ILIT), so the death proceeds won’t be included in his taxable estate. John has a daughter, Jill, a 50-year-old G2 potential client with a net worth of $200,000. Jill also has a young daughter.
During the planning process, the conversation with John evolves into a legacy planning discussion. After John learns certain details of the projected inheritance strategy, he wishes to establish a more comprehensive legacy plan and brings Jill into a meeting. The advisor recognizes that John’s estate plan calls for $4 million of his estate to be left to Jill on his death. John wants to lock in a legacy plan for his granddaughter, but is advised that Jill’s current net worth won’t justify more than approximately $425,000 of life insurance. The advisor illustrates what death benefits may be justified for John and Jill with and without the use of a projected inheritance strategy. (See “Strategy in Action,” p. 45.)
Projected inheritance guidelines are used to assist in Jill’s financial justification. In the end, the $4 million that Jill expects to inherit financially justifies an additional $3.6 million of death benefit on her life or over nine times more death benefit than she otherwise would have qualified for. Using Jill’s projected inheritance results in the ability to purchase over 40 percent more total death benefit between John and Jill. John is pleased with the amounts of coverage and elects a cost-effective death benefit life insurance policy, while Jill elects a cash accumulation life insurance policy for added flexibility and tax efficiency over Jill’s life. Lastly, John forms one ILIT to own the policy on his life and a separate ILIT to own the policy on Jill’s life. Both are funded by John using a portion of his gift tax exemption to support future premium payments.
The benefits of a legacy plan that leverages a projected inheritance are clear. In this case, John was able to reduce the size of his taxable estate, while creating an effective legacy plan. He used his current assets to justify coverage on Jill’s life, a strategy that was generally not an option in the past. John also leveraged his gift tax exemption to efficiently fund the coverage. Jill secured needed life insurance today, locked in her insurability and identified a source of premium dollars to sustain coverage for the long term. Finally, both John and Jill were able to purchase policies that not only met their immediate and future liquidity needs, but also provided attractive IRRs that position life insurance as an asset class to diversify a portfolio and stabilize wealth transfer.
Taking the Next Step
Clients regularly need updates from advisors regarding tax and planning issues as the environment develops. Within the context of those conversations, the importance of establishing a legacy plan should be discussed, along with the significant benefits this planning can offer. Clients need to know the possibilities of leveraging their gifts with a projected inheritance to help protect both current and projected estates. Advisors should consider taking the following steps to ensure their clients don’t miss out on this opportunity:
• Follow up with uninsurable clients to discuss extending their legacy by insuring their heirs.
• Raise the issue of legacy planning with existing G1 or G2 clients. Discuss what they want to happen when their beneficiaries receive the death benefit and how to safeguard that goal.
• Talk to existing clients with living parents about how a projected inheritance could significantly increase their insurance needs.
Aside from becoming a valued client advisor, legacy planning allows for the conversation to extend to either a parent or adult child, resulting in a more effective and comprehensive plan. Ultimately, the advisor has the opportunity to become a true family advisor and show clients the value of life insurance across multiple generations in achieving an effective legacy plan.
—Disclosure: Skipping or reducing premium payments will result in a lower cash surrender value and death benefit. Clients must consider their ability to possibly pay higher premiums in later years. Policy loans and withdrawals reduce the cash surrender value and death benefit and may reduce the period during which coverage stays in force. Life insurance is not a deposit of any bank, is not FDIC insured, is not insured by any federal government agency, is not guaranteed by any bank or savings association and may go down in value.