Decoding Life Insurance

By Sean Brady | April 17, 2024

Life insurance is often unnecessary for ultra-high net worth families. But in the right circumstances it can be a powerful planning tool, helping to provide estate liquidity, fund buy/sell agreements, or shelter taxes. Here are a few brief highlights:

Income replacement. High earners, as opposed to those with considerable assets, should consider life insurance (and possibly disability insurance) if the loss of income would materially affect their family’s quality of life. Term insurance is usually sufficient to mitigate this risk. Cash-flow projections will be important in determining the size and duration of the policy, but it’s fair to say that most young families could benefit from some form of coverage.

Estate liquidity. Families with a taxable estate of primarily illiquid assets, such as real estate or a family business, can arrange for life insurance to pay state and federal estate taxes, avoiding a forced sale at the owner’s death. Section 303 of the Internal Revenue Code allows an estate to sell shares back to a closely held business to cover estate taxes without being taxed as a dividend distribution in certain cases. Section 6166 allows beneficiaries to extend payments for all or part of the estate taxes attributable to the business for up to 14 years if certain conditions are met. Executing these arrangements can be a complicated and costly process, however, and should be considered very carefully.

If estate liquidity is an issue for a married couple, a simple solution may be a second-to-die universal life insurance policy. Usually, a well-planned estate pays taxes only at the passing of the surviving spouse. A second-to-die policy will only pay out on the death of both spouses, which drives down the cost of insurance. It provides long-term coverage at a relatively low cost.

Estate equalization. Parents who want to transfer a family-owned business to children active in the business without shortchanging other children can also consider a second-to-die universal life policy if there are not enough assets to equalize inheritances. Again, comprehensive estate and trust planning is necessary in navigating the related tax, control, and distribution issues.

Funding buy/sell agreements. Business partners can arrange for insurance to help cover the purchase of shares at the death of one or more of the partners. These policies work best as part of a robust buy/sell agreement and business succession plan that details business continuity in the event of retirement, disability, or death. Term or universal insurance may be appropriate, depending on the broader plan and participants.

Tax sheltering. Private placement life insurance, or PPLI, is a form of variable universal life insurance that can be a powerful tax sheltering tool for high earners with large balance sheets and significant liquidity. These policies allocate investments to liquid and to illiquid investments, such as hedge funds or private equity partnership interests, and shelter the income tax liability generated from distributions. Policyholders should have a decades-long investment time horizon, but the result can be a significant savings on income and, eventually, estate taxes, especially when combined with an irrevocable life insurance trust.

It should be noted that PPLI has come under recent scrutiny, with the Senate Finance Committee suggesting that regulators take a closer look at these policies.

When deciding where to get advice on your policy, remember that an insurance provider’s sales incentives should not drive your decisions in buying, keeping, or terminating an insurance policy. Please contact your advisor at Evercore Wealth Management and Evercore Trust Company, N.A. for an objective discussion of your family’s insurance needs and how insurance fits in with other aspects of your comprehensive wealth plan.

Sean Brady is a Managing Director and Wealth and Fiduciary Advisor at Evercore Wealth Management and Evercore Trust Company. He can be contacted at sean.brady@evercore.com.

Defining the terms

Here are the major types of life insurance and considerations for high net worth and
ultra-high net worth families:

Term insurance provides an income tax-free payout to one or more beneficiaries at the insured’s death. Premiums are usually quoted as “level,” meaning the premium stays flat throughout the term of the policy. But be aware that policies can be annually renewable, meaning premiums start out smaller but increase every year, eventually becoming prohibitively expensive. The frequency of premium payments also matters. Payments made more frequently than once a year may be slightly more expensive. It’s important to note that if the term policy matures and the insured’s medical condition changes, it may be very expensive, or even impossible, to acquire a new policy to continue coverage.
Whole Life is a form of permanent insurance, meaning the death benefit is not limited to a term. There’s a savings component in these policies called cash value that can be withdrawn (with costs) or borrowed against. Whole Life is significantly more expensive than other forms of life insurance because of the cash value component and the flexibility it provides.

Whole Life tries to solve for multiple objectives with one product, and as a result does not solve any efficiently. If a family needs a death benefit, Whole Life is the most expensive form of insurance. If they are interested in the savings component, there are other strategies with greater expected returns on an after-tax basis. If a family needs the liability protection offered by Whole Life, trusts can accomplish this with greater flexibility.
Universal Life is another form of permanent insurance with a cash value component. Policyholders can opt for guaranteed, variable, or indexed policies to determine how the cash value grows. Guaranteed policies provide a minimum return on cash value, while variable policies allow the owner to invest cash value in stocks, bonds, or alternatives. The cash value of an indexed policy can match the performance of an index such as the S&P 500 but usually with ceilings and floors on returns.

Universal Life uses premiums and cash value to pay for the cost of insurance over time. This is important because policies can lapse if any of the underlying assumptions negatively affect the performance of the cash value. Families may find themselves forced to choose between letting the policy lapse (losing some or all their investment) or paying materially larger premiums to cover the cash value shortfall.

– SB

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