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Life Insurance & Estate Planning with Guest Terry Headley, LUTCF, FSS
James Lange, CPA/Attorney
Guest: Terry Headley, LUTCF, FSS
Please note: Some of the events referenced in our audio archives have already passed. Please check www.retiresecure.com for an updated event schedule.
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- Introduction of Guest –Terry Headley, LUTCF, FSS
- Price Increases For Universal Life Policies
- Life Insurance As A Guaranteed Investment
- Client Profile For Guaranteed Universal Life
- Life Insurance With A Long-Term Care Rider
- Candidates For A Second-To-Die Life Insurance Policy
David: Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks. I’m David Bear, here in the studio with James Lange, CPA/Attorney and author of two best-selling books, “Retire Secure!” and “The Roth Revolution: Pay Taxes Once and Never Again.” Our topic this week is life insurance and the role it plays in estate planning. On January 1st, new rules kick in that are changing the role life insurance might play in your future financing and estate planning. Joining us by phone is Terry K. Headley. With nearly four decades of experience in the insurance business, Terry is more than well respected in the industry. He’s an authority. Among his numerous accomplishments, he has testified before Congress on insurance-related matters, he’s a life member of the Million Dollar Round Table, and is managing partner of Headley Financial Group in Omaha, Nebraska. Listeners, since our show is live, Jim and Terry are available to answer your questions. To join the conversation, call the KQV studios at (412) 333-9385. And stay tuned for an interesting and informative conversation. With that, I’ll say hello, Jim and welcome, Terry.
Jim: And thanks for joining us, Terry.
Terry: Thank you.
Jim: This is the first time we’ve actually had two radio shows in a row on the same topic, and we have, I think, rarely talked about life insurance, but the change that David was referring to on January 1, 2013 is going to be significant pricing increases. So, what I have done in my practice is by direct mail, plus this radio show, and actually calling people, is telling them if you have a need for permanent life insurance, and by permanent, I don’t mean term, but something that will last for the rest of your life that you actually plan to die with the product. If there is a need for permanent life insurance, and if rates are going up anywhere between 8% and 15%, and in some cases I’ve heard as high as 25%, it makes sense to lock in the policy by getting an application dated as soon as possible, and certainly before year-end. Last week, we had Tom Hall on. Tom is the Pittsburgh broker, the owner of the brokerage service that I use for my own personal needs, and by the way, I should mention that I and my wife just applied for a million dollars of guaranteed universal life ourselves, and Tom provided very good information and a lot of insights, and as good as he is, he is a local guy, though, and I thought that this week, I would have a nationally-recognized expert, Terry Headley, provide his experience. So, Terry, welcome to the show.
Terry: Thank you, Jim. It’s good to be with you this evening.
Jim: All right, so, could you inform our listeners, what types of policies are going to…or maybe not all of them, but at least most of the, let’s say, more common policies that some of our listeners might be interested in. What types of policies are going to experience a dramatic increase, and can you talk a little bit about the price increases that you foresee?
Terry: Yeah, Jim, thank you. Well, the impact is to the universal life product lineup, which includes the secondary guarantee, and that secondary guarantee is basically constructed in a way that it guarantees that the policy will not lapse. In effect, the policy holder, the owner actually is transferring all of the risk, or mortality experience and interest rates, back to the insurance company, and the tradeoff on that, Jim, as you know, is that the individual then is promised a guaranteed premium, a plan premium, that will keep that policy in force. So, this new actuarial guideline 38, which the National Association of Insurance Commissioners has adopted as of September 12th of this year, basically says that there is going to be a requirement that must increase the reserves to support those long-term guarantees. So, where we are seeing the premium rate adjustments in terms of increases is kind of in the shorter pay, the premium paying periods of single payment, five-year, ten-year pay lives, and those types of universal life policies, again, with the secondary no-lapse guarantee that would bring over funds under a provision known as 1035-A, which allows for tax-free exchanges under the internal revenue code. We’re seeing in the range, as you indicated, between 5% and upwards to 25%, again, depending on the age, the amount of the policy, the risk classification and gender of the policyholder.
Jim: All right, now, you used the word ‘secondary guarantee,’ and this is very important because…now, I have certainly not been in the life insurance industry, and actually, life insurance, as you may know, is just one facet of what we do. In fact, I use it almost as a compliment to a retirement and estate plan. So, I’m not as insurance-centered as, say, a pure insurance guy, but I have seen a lot of policies where the clients bought when they were younger, and now, they are starting to approach the age limits on those policies, and they are afraid that they are going to survive the policies, and if they don’t come up with a lot of money, the policies could crumble and fall apart, and I was just with somebody, and it’s going to cost them a couple of hundred thousand dollars just to keep the policy in place that he already bought. So, you’re talking about a policy now, as I understand it, that that isn’t going to be a problem. It’s a, let’s say, a relatively simple policy where if you pay the premium every year, and as you insurance people like to say, ‘when the policy matures,’ that is, when somebody dies, there is a death benefit, and there’s no issue of having the policy lapse unless you miss a payment. Is that the type that you’re talking about?
Terry: It is, Jim. You’re exactly on point there, and, again, by transferring the risk, and of course, the previous universal life plan designs, really the consumer, the policy owner, was assuming those risks for the mortality expenses and interest rate risk, rather than the company. So, again, by paying the stated plan premium on a universal life with a secondary guarantee, it assures, it guarantees that that policy will stay in force for the life expectancy of the policy holder, and they can bow that all the way out to age 121, which now is the new mortality table.
David: Hah! That’s good to hear!
Jim: All right. So, if this is a guaranteed policy, and assuming the life insurance company is solvent, and I guess, even if it isn’t, there’s a consortium. So, as I understand it, no life insurance company has ever failed to pay a claim in the United States. Can you also look at this in some manner as a guaranteed investment?
Terry: Well, you could. Obviously, you know, it is life insurance and by definition, it is primarily in place to create a tax-free death benefit to the beneficiaries, but yes, you could look at it as an asset class in and of itself, and that is the way we have been approaching it with many of our clients is to position life insurance as an asset class within the portfolio.
Jim: Well, I was actually just looking today for a client, and they were not the healthiest folks in the world. The husband had diabetes, and we got a quote, and they were in their early sixties, and the quote that I ran was if they live until, or at least, if one of them lived until age 87 and 85 (this is, I guess I’m mixing products now, jumping to the second-to-die, I want to go back), but I just want to give you an idea of the interest rate that I got, and I calculated that if they made it until age 87 and 85, that the premium that they would pay would end up being, in effect, a guaranteed 8% return on investment, and if they died earlier, that it would be significantly higher, and in today’s environment, you know, where people are getting 2%, 3%, sometimes even less, on a fixed-income investment, this isn’t a terrible way to go for people who are a little bit averse to the stock market and don’t want to have all their eggs in one basket.
Terry: Yeah, exactly, and that again, Jim, is how we present it to our clients in terms of the internal rate of return, and as you said, the calculation you were arriving at was 8%. But again, think about the taxable return that would have to be earned because life insurance death proceeds payable to a named beneficiary are income tax-free.
Jim: Well, I know. That’s such an amazing thing. So, let’s say for discussion’s sake, on a million dollar policy that over time, depending on age, etc., the total premiums might be $300,000 or $400,000, and then the family gets $1,000,000, and normally if you buy something for $300,000 or $400,000 and you sell it for $1,000,000, you have to pay a capital gain on the difference.
Jim: Normally, if you make contributions to a retirement plan totaling $300,000 or $400,000 and you eventually withdraw $1,000,000 you have to pay ordinary income tax on the difference. Normally, if you die with an asset, that asset is included in your estate, and, in Pennsylvania, we have a 4 ½% inheritance tax even on the first dollar, and for federal, depending on what the exemption is, it could be part of your estate. But assuming that the paperwork is done right, life insurance is not taxable for income taxes or for estate tax purposes.
Terry: Right. That is correct, Jim. And in addition to that, almost all states exempt life insurance from any state inheritance tax or state estate tax.
Jim: Yeah. That’s just such a wonderful lobbying group that the life insurance company has, but frankly, I’m not here in terms of social commentary, I’m here…and actually, the way I do my whole career, Terry, is I take a look at what the rules are, and rather than argue that we should change them, or we should keep them or anything else, I say, “Okay. These are the rules. What is the best way to arrange client’s affairs so that they get the maximum benefit?” And, to me, in terms of saving taxes, life insurance is probably the best, maybe followed by Roth IRAs and Roth IRA conversions and Section 529 plans. But certainly, from a tax perspective, I find life insurance to be a wonderful tax-free vehicle. Is that your experience also?
Terry: Well, absolutely. The, you know, tax efficiency and cost effectiveness of life insurance is pretty hard to duplicate, even in other well-known investments, and the nice thing about it is it is not correlated in any way really to the bond market or the equity markets. And, so, it is again an asset class that can exist on its own, very attractive internal rates of return, as you were indicating, Jim, and then again, the multiple tax benefits, again, properly structured with the appropriate ownership and beneficiary arrangements, can pass outside of the estate, clearly is exempt from federal and state income tax, as well as state inheritanced and state estate taxes.
Jim: Okay. If you are just joining us, we are talking with Terry Headley, who is really one of the very well…I’m sorry, I got his name wrong. Oh, no I didn’t! Terry Headley, and the reason why we are talking about life insurance now is because the rates for permanent policies are going up, let’s say, between 5% and 25%. We found for most of the types of policies that we recommend, maybe between 8% and 15% by the beginning of the year or before that, and so we are encouraging anybody that has a need for these types of policies to get their application in as soon as possible, certainly before year-end, to take advantage of the lower rate. Terry, do you think that this is particularly important in light of some of the uncertainty of what’s going on with our political process, the uncertainty as to what’s going on with estate taxes, and the fear that we might have an investment problem with the fiscal cliff?
Terry: Mmm-hmm. Yeah, I think life insurance becomes a very stabilizing component to any retirement, estate or personal planning, Jim, and again, in these times of great uncertainty, the volatility of the markets, the low-interest rate environment that we find ourselves in, life insurance certainly deserves strong consideration, and particularly at this time as you are indicating because of the incentive, because the rates are only going to go higher on these new policies, the universal life policies with the secondary guarantee start on January 1st of 2013 and beyond, because of the higher reserving requirements that are going to be imposed under this new actuarial guideline 38, which has been a work in progress for now seven years. But it is just a consortium of actuaries and consultants and the regulators that have finally come to harmonization and an agreement relative to what these reserving requirements will be.
Jim: All right. Well, I know there are certainly other types of policies that this will be affected, for example, life insurance with a long-term care option or rider and second-to-die life insurance. But let’s go back and talk about universal life and what type of listener should be thinking about that, but if we could do that after the break, I would sure appreciate that, so can you hang on with us?
Terry: Oh, absolutely, Jim. Thank you.
Jim: All right, very good.
David: Well, then, when we return, Jim and Terry will continue the conversation. If you have a question or comment, call the KQV studios at (412) 333-9385.
David: And welcome back to The Lange Money Hour. I’m David Bear, here with Jim Lange and Terry Headley. But before we continue the conversation, I want to remind listeners that our November 28th show will have a special guest, John C. Bogle, founder and long-time CEO of the Vanguard Group, the world’s largest index and mutual fund company, and if you visit the Lange Group website, www.paytaxeslater.com, and click on ‘Ask John Bogle,’ we’ll send you a copy of the audio file and a transcript of the entire show. Jim?
Jim: Okay. So, we were talking about the increases that are going to occur in many of the permanent life insurance policies, and I am encouraging listeners to see their insurance agent if they have one, or consider even a consultation with my office if you do not, because the prices are going up on January 1, 2013, or even before that, and we were talking about different types of policies, and we are here with Terry Headley, who is a national expert, member of the Million Dollar Round Table and lots of other accolades, and Terry was about to tell us what type of listener or client he usually recommends a guaranteed universal life for. What type of person would be a good candidate and could benefit the most from these types of policies?
Terry: Yeah, Jim, thank you. You know, the client profile that we would try and identify is somebody that is somewhat risk-averse and we certainly are finding that amongst our existing clientele, as well as new client referrals, that there is just an aversion to all kinds of risk, largely, probably, due to the psychology of the equity markets and the bond market and everything else. And so, what we’re looking for is somebody who appreciates guarantees and is willing to commit long-term to a pattern of planned recurring premiums that must be paid in order to keep these universal life policies, again, with the no-lapse secondary guarantees in place, and who wants to make sure that they don’t outlast the coverage, which is the case, as we were discussing earlier, where many of the universal life policies actually are imploding. In other words, they were being projected on unsustainable interest rates that have not materialized and we all know the tremendous collapse in interest rates. Also, we’re assuming improvements in mortality that probably were unsustainable and unrealistic. So, the secondary guarantee of universal life is a great fit for clients that do want long-term protection, they want the policy to be there for their families, for their businesses or for their estate, for charitable institutions, whatever, for the long-term, and again, the coverage can be dialed to any specific age. If somebody says, “ Well, I have not a good family history in terms of health history and everything,” they might want it only to go out to age ninety, or eighty-five. So, you can actually dial the age that the protection will go to, and then, of course, with technology, we’re able to calculate what that premium would be to sustain that policy, again on a guaranteed basis, for all of the risk have been transferred to the insurance company for interest rates and mortality.
David: Well, once established, though, the premiums wouldn’t rise with age. They would be set?
Terry: That is correct. It’s a level premium policy, and you can have a level death benefit or an increasing death benefit, depending on the death benefit option selected.
Jim: All right, so let’s do the profile. So, you said that the person is sometimes risk-averse. Let me give you an example of somebody that I was in with today. A husband and wife, and their goal, their stated goal, which is probably the unstated goal of most of my clients, which is first to make sure that there’s enough money to live comfortably for the rest of both of their lives, and second, after the first one dies, that the survivor is well provided for and could at least maintain lifestyle. And that was the stated goal, and in this case, the husband worked for a company that had a traditional pension plan, and when it came time to make the options for what type of payout he wanted, he wanted a single pay. That is, it only paid ‘X’ dollars a month for the rest of his life, and with that pension, if he survives, there is more than enough money for him and his wife, but if he dies, she literally would’ve taken about, between the reduction in his pension and the reduction in Social Security, in this case, it would’ve been about a $25,000 hit and she wouldn’t be able to maintain lifestyle. Does that sound like a good candidate for a universal life, assuming that he is still insurable?
Terry: Absolutely it does, and I think that is an ideal client profile to take a look at, and again, I think the real key to all of this is knowing…what we’re finding is, if we kind of do our planning around the financial pyramid, and at the base of that pyramid, and the foundation of any good financial plan are risk management tools. Life insurance clearly is a risk management tool in which we have, again, the strong guarantees that cannot be overridden or modified because it is contractual. It’s a legal contract between the policyholder and the insurance company that those rates are going to be guaranteed and that that policy will be guaranteed to remain in force, irrespective of what happens to the mortality experience of that company, or whatever direction interest rates may go.
Jim: And another client that I had today, actually a younger client, both still working, and they both had life insurance through their employer, but I said, “Gee, if you get sick and you lose your job, now you’re sick. Nobody will insure you when you’re sick, and then if you die, you’re going to die without any insurance.” So, I was recommending, since they were on a limited budget, rather than having, say for example, a million dollar permanent policy, which would be pretty expensive, that they should have actually more than one term policy, but to have a small permanent policy. I don’t know if you ever make recommendations like that, or if you’re an all-permanent type guy?
Terry: Well, ideally, we like to get, you know, as much permanent in place as we can, Jim, but certainly, there is nothing wrong, and again, the consideration comes in with the discretionary income, and the cash flows that are available though their budget in order to put in place. So, sometimes, you do have to put together a package, or combination, of life insurance products. Certainly, term insurance in the early years…there’s a very, you know, cost effective way to do that, but, you know, over time, we want to make sure that we’re converting that incrementally, or all at one time as income and cash flows within the households improve. So, I think that’s, you know, another way to certainly approach it, and again, what you’re doing with the term insurance is you’re locking in insurability so that that conversion would be guaranteed into the same risk class that they enjoy under the issued term policy. Jim, I might mention just for your listeners, some kind of challenging data, you know, that comes out of a LIMRA, which is the Life Insurance Research and Marketing Association, and they tell us that only 40% of the households now own personal life insurance as opposed to that from an employer sponsored group-term life arrangement. So, only 40% of the households in the average amount of coverage is 2/12 times household income. So, we have a public that is greatly, vastly underinsured, and I think it is up to advisors such as ourselves to make sure that we start to close that defecit, that gap in their planning.
Jim: I had no idea it was that bad. I really didn’t, because I guess the type of people that come to see me…and by the way, I mean, very frankly, I have a lot of college professors and engineers, and they’re both a little bit hostile to life insurance, in general. But they have better statistics than you just gave us!
Terry: Mmm-hmm, yes.
Jim: That’s pretty tough.
Terry: It really is, and unfortunately, the trend line, Jim, is going the wrong direction with fewer and fewer households over the last five to ten years owning any personal life insurance. So, there is a little bit of an over-dependency upon the employer-based plans and everything, and as you indicated, those are not portable. If an employee were to leave, they are convertible, but at very high rates because the assumptions on those conversion policies take into account that these are people that could not qualify on their own, so, you know, they don’t want any adverse selection. But, anyway, it becomes quite prohibitive from a cost standpoint to do the conversion.
Jim: Okay. Now, we were talking about what types of people would be appropriate for, let’s say, a guaranteed universal life with a secondary guarantee, or is that redundant? Is guaranteed universal life the same thing as universal life with the secondary guarantee?
Terry: Yeah. It’s common in the industry to refer to it as ‘universal life with the secondary guarantee.’ You even see the acronym, SGUL, secondary guarantee universal life, as the acronym.
Jim: Okay. So, let’s say one situation would be for married people, where if one of the spouses died, there would not be sufficient resources for the survivor to live in the manner in which they are accustomed. Is that a fair…?
Jim: Okay. The other one that I see in practice…I’m thinking about a single mom who has young children, and, in the event that something happens to her, those kids are going to have a pretty rough time, and one of her children has a special disability where it is unlikely that that child will ever be able to make a living and will need some kind of assistance, potentially for the rest of his life. So, is that a situation where a guaranteed universal life, or a universal life with a secondary guarantee, would be appropriate?
Terry: Yes, it would, Jim, and, you know, again, these are all scenarios in which, clearly, you know, universal life with a secondary guarantee would be very suitable and a good fit in those client circumstances.
Jim: All right, and if you are her and you are on a limited budget and you have an option between applying for that policy now and applying for that policy after year-end when it might be between 8% and 20% more expensive, it sure makes sense to do whatever you need to do to get that application in and dated as soon as possible. Is that fair also?
Terry: Well, that is fair and I totally agree with that, and, in addition, you know, we always say purchasing life insurance is kind of like making sure that you have your parachute ready because we all kind of walk this thin line of insurability, and at any time, any given day, any of us could cross over that line of insurability. So, life insurance, unlike many investment solutions, you do have to quality for it from a financial and medical standpoint.
Jim: Yeah, and by the way, I have to admit I was one of those people who kind of slacked off a little bit on permanent insurance. My wife and I each have a million dollars of term on each other, and we are approaching, within five years or six years, of that term running out, and right now, we’re both insurable, so we’re thinking, “Hey, you know, our term insurance is going to run out, we’re going to need something, and frankly, we’re both…we’re mainly interested in providing for each other at this point, but then, also, ultimately, our daughter.” So, we are actually getting a million dollars of universal life with the second guarantee for each of us. So, I’ll just say that this isn’t just some theoretical issue that I’m trying to push on other people. It is something that I am doing myself.
David: Will you continue with the term policy though, too?
Jim: Yeah, I will certainly continue with the term policy because, frankly, the later years of the term policy is kind of like a great deal. So, I think that we had twenty-year term policies, and it’s known as a ‘level term,’ which, frankly, if we’d had a shorter period policy, the rates would’ve been lower, but now, if we were trying to get a policy towards the later part of the term, it would be more expensive. So, we’re certainly going to maintain the term policies, and then supplement, and then our main policy will be a universal life with a secondary guarantee.
Terry: Mmm-hmm. Yeah, Jim, there would be, of course, the conversion privilege under the existing term policies that you could take over to the secondary guarantee universal life, as well.
Jim: Yeah, that’s right. And actually, what we are doing in our practice for people who have existing policies is rather than just starting fresh or blindly adding more, we are actually doing a review of the existing policies to see what is there, what are the options, does it make more sense to keep what is in place, or does it make more sense to start all over, or some combination thereof?
Jim: So, we are doing that. And actually, by the way, that’s where Tom Hall, who is the local broker and very knowledgeable and very, very helpful.
Jim: So, when we do come back, I want to talk about life insurance with a long-term care option, and I also want to talk about, or I should say, a rider, and I also want to talk about second-to-die life insurance. These are both forms of the type of guaranteed, or permanent, policies that will experience this price increase.
David: Well, we’re going to take a final break now, and when we return, Jim and Terry will continue the conversation.
David: And welcome back to The Lange Money Hour with Jim Lange and Terry Headley. There’s till time to join the conversation if you call KQV studios at (412) 333-9385.
Jim: So, we are talking about the pending increases in the life insurance products and the permanent life insurance products, and we talked about a universal life with a secondary guarantee (I always think of it as guaranteed universal life), but anyway, a relatively simple product where if you pay the premium, the death benefit is guaranteed. And now, we wanted to talk about life insurance with a long-term care rider. I always kind of think of it simplistically as a combination life insurance and long-term care. So, Terry, could you tell us what your experience is with these types of products, these combination products, and whether you like them or not?
Terry: Yeah. Jim, we are starting to get more proactive with, you know, the universal life with the long-term care rider, the universal life being the chassis and, of course, the long-term rider is added to the base policy. They’re also known as ‘hybrid’ or ‘linked’ products. But it is purely just a matter of, from a construction standpoint, the design is to advance a percentage of the death benefit over a period of time at some rate, anywhere from 2% to 6% of the face amount on a monthly basis. I think this product makes all the sense in the world. To me, it is a life cycle-type of a product. We have had clients that have been a little bit resistant at times to buy the standalone long-term care policies because what if? The probability exists that I may not ever use it. And therefore, I have sunk a lot of premium dollars into that product and I’m never going to see a benefit from it. And with a long-term care rider attached to the base universal life policy, you are assured, at least at the end, there will be some residual death benefit if, you know, the long-term care benefits, you know, have not been consumed as part of those draw downs on a monthly basis.
Jim: All right. So, let’s take an example: let’s say somebody gets a $500,000 universal life with a secondary guarantee and a long-term care rider. And let’s take a couple examples. So, now, the person has $500,000 of coverage, and let’s say that he does experience the need for long-term care, and let’s not worry about the monthly limits for the moment, and let’s just say that he ends up using $200,000…he needs care for $200,000, and the policy would pay him $200,000, and then he either gets better or he doesn’t get better, and then he dies. So, what would the death benefit be on a $500,000 policy where he uses $200,000 in lifetime benefits for long-term care? Would he just get the difference?
Terry: Yes, primarily, it is the difference. There is a little bit of a, you know, an internal assumption, interest rate assumption on that, but it would be very close to that number.
Jim: All right. So, basically then, to oversimplify, if you have a $500,000 policy, you need $200,000 of care. That care comes from the insurance company itself, or is paid for by the insurance company. You die. You get the difference between the face amount of the policy and the amount of care that was provided before you died.
Terry: Right, yeah.
Jim: All right. Let’s take example #2. You buy this $500,000 combination product and you never need care. And then you die. You would get the entire $500,000?
Terry: The full-face amount would be intact. That is correct.
Jim: Okay. And the other nice thing about it is this is also a guaranteed price product. Is that correct?
Terry: It is.
Jim: All right. Well, that’s more than we can say for traditional long-term care that continues to rise all the time, it seems.
Terry: Right. I would agree, and the long-term care rate adjustments, you know, create great consternation amongst many clients because the frequency of those rate increases is happening more often, and a lot of times, people, our clients just can’t absorb that within their monthly budgets, so then, they’re having to make adjustments to the plan design, either downsizing the amount of the daily benefit, lengthening the elimination period, the waiting period before the benefits commence, or shortening the benefit period.
Jim: You have a great way to say it. You almost sound more like a lawyer than I do when you say that the price increases cause great consternation among the insured. What I would be thinking is the guy who bought the policy is freaking out because he’s experiencing a 17% rate increase! There’s not too much he can do about it other than reduce his benefits or just suck it up and pay more. But you don’t have that kind of problem with the guaranteed universal life with the long-term care rider.
Terry: That’s correct, Jim, because, at it’s core, you are buying a secondary guarantee universal life policy that just happens to have a rider, but what it is doing is advancing, on a monthly basis, a portion of the death benefit.
Jim: All right. And is it also fair to say that if you are trying to get a policy, that in general, it is easier to be insurable for a life insurance product as opposed to a long-term care product?
Terry: Jim, actually, you’re kind of on a duel track when it comes to the underwriting. So, they are underwriting life insurance as life insurance, and they’re underwriting long-term care more from a disability standpoint.
Jim: Oh, okay. So, if you have something that might not be life threatening, but would increase your chances of needing care, that would be taken into account in the price of the policy. Is that right?
Terry: Yeah, yes, exactly, yeah. So, you kind of have two separate underwriting processes that are running in tandem as you underwrite this type of a hybrid or linked product.
Jim: Okay. Well, it’s interesting that both of us independently, and this is not a terribly popular product on the market, but both of us independently determined that we like it, and Tom Hall, who is the local Pittsburgh broker, he is actually…and I don’t know how this matches your experience, but he is actually selling more of these combination products, that is, the universal life with a secondary guarantee and a long-term care rider than he is with even just traditional long-term care insurance.
Terry: Mmm-hmm, mmm-hmm. Yes, I think you sometimes will find, at least in our practice, we find a difference of opinion between husbands and wives, which is kind of interesting because the wives will gravitate towards a standalone long-term care policy, and the husband says, “I’d prefer to have the universal life with a long-term care rider,” which is an interesting conversation to, kind of, at times, referee or be the liaison.
Jim: Well, at that point, maybe…and I know you have been married for a long time, but what I would say is, “Whatever you like, dear.” That’s the key to my marriage, but I’ll be honest with you. I would give her a little bit of a problem because I like the idea that if you don’t need the long-term care, that the death benefit stays intact, and it might go for the spouse if it is needed, and then if the spouse dies first, then it can go to your children.
Terry: Right, exactly.
David: But if you get this payout, you’re still going to have to keep making premium payments on the policy, won’t you?
Jim: Well, that’s a good question. So, let’s say, for discussion’s sake, that you buy a $500,000 policy and the premiums are, depending on your age, a couple of thousand dollars a year, and now you need long-term care, and now you’re starting to receive a long-term care benefit from the policy. Do you have to continue paying the policy?
Terry: Well, you probably will have a waiver of the premium, a rider that waives the premium at any time that you’re receiving the long-term care advances, which are, again, advancing the face amount or the death benefit of the policy.
Jim: Okay. And the last type of policy that I don’t want to neglect, because it is actually my personal favorite for a lot of clients, is the second-to-die life insurance policy, and maybe you can tell us your perspective on that? I know I am a big fan of it, particularly…and Pittsburgh’s a working town, and probably the majority of my clients have as much or more money in their IRAs and 401(k)s and 403(b)s and qualified plans as they have outside their IRAs, and I like to preserve those IRAs and retirement plans and the tax-deferred feature, or in the event of Roth IRA conversions, which is another great favorite tax vehicle, I like to preserve those for children or even grandchildren, and by creating an estate with a second-to-die life insurance policy, we often can better preserve these retirement assets to enjoy tax-deferred or tax-free growth for one, maybe two, generations. That is, for children, or even grandchildren. And I was curious if that was a product that was part of your arsenal?
Terry: Yeah, it really is, Jim. You know, we’re big proponents of the second-to-die and the survivorship universal life policies, again, not only from a tax efficiency standpoint, but from a cost standpoint, because what you’re doing is effectively combining the joint mortalities of husband and wife (and we’ll use that as the example), into one policy. So, there are some economies of scale by having those in one policy. And again, it’s important for listeners to know that the policy pays off on the second death, in other words, the survivor’s death. So, at first death, there is no life insurance death benefit, and it pays at the second death only. But it is ideal for a number of business owners. It is ideal for, obviously, estate planning, and as you’re talking about some of the stretch opportunities with qualified assets and everything, it is ideal as a means, as a replacement asset to not have to consume or spend down the IRA assets and everything, whether that be Roth or traditional.
Jim: I tend to use more of it when a couple has hit, what I call, their number. So, let’s say that somebody says, “Hey, between my Social Security and maybe pension”, or whatever other sources of income that they have from non-portfolio income, typically after retirement but not always, “I need ‘X’ dollars a month from my portfolio,” and let’s just say, for discussion’s sake, they said, “Well, I need $40,000 per month from my portfolio,” and let’s just…without getting into a long discussion of safe withdrawal rates, depending on age, let’s say that that means that they need $1,000,000 in their portfolio, but let’s say they have $2,000,000. They might be a very good candidate for the second-to-die policy because they can afford the premium. It is, in effect, a gift to their children, and they can afford to make the premium, and the numbers that I’ve run are the combination of the second-to-die and the ability for the children to continue the stretch IRA and the stretch Roth IRA after both husband and wife die, can be hundreds of thousands, and in some cases, millions of dollars better off for the family.
Jim: So, I don’t know if that is something that you tend to do. You tend to think that the better candidates for a second-to-die are people who have hit…I call it, you know, kind of, the ‘number.’
Terry: Mmm-hmm, mmm-hmm. Yeah, I think it is an integral part of that type of planning, and again, as we talked about earlier in the program, you know, again, the tax advantages, the tax benefits the life insurance enjoys are second to none.
Jim: I know. To me, it’s pretty astounding. So, let’s say you buy a million dollar policy and the premiums, depending again on your age and your health, etc., might be $10,000 or $15,000, so maybe over time you pay $200,000 or $300,000 in premiums, and your kids get $1,000,000. Normally, it seems that they would have to pay income tax, or at least capital gains, on the difference between what you paid and what they got, and, in addition, since it’s a transfer of death, or, at least conceptually, it is, there would normally be estate or inheritance taxes, and this is all tax-free, which I just think is a wonderful feature.
Terry: Right, right, exactly, and then, with the ability to remove those proceeds from the estate, if there is an estate tax issue, and of course, we’re all over the spectrum in terms of the range of possibilities on where this may land. You know, we’re currently at $5.12 million for each person. Husband and wife could have $10.24 million with, through proper planning and not have any estate tax now, but again, that all sunsets on December 31st, and, you know, we’re thinking that the conventional wisdom and consensus is rallying around a $3.5 million exemption with a 45% tax rate.
Jim: Yeah, so we’re just about out of time. I hate to cut you off, but the conclusion is the permanent life insurance policies, that is not term, and today we talked about the universal life with the secondary guarantee, life insurance with long-term care option, and the second-to-die life insurance, the prices are all going up. We’re encouraging people to see their insurance professional. In the event that they don’t have it, that our office is offering an assessment, and we are available at (412) 521-2732.
David: Well, and thanks to the audience for listening to this edition of The Lange Money Hour, Where Smart Money Talks. Thanks to Terry Headley for his insurance industry insights. Thanks also to our program coordinator, Amanda Cassidy-Schweinsberg, and Dan Weinberg, our in-studio producer. As always, you can hear an encore broadcast of this show at 9:05 this Sunday morning here on KQV, and you can always access the archive of past shows, including written transcripts, on the Lange Financial Group website, www.paytaxeslater.com. Please join us for the next edition of the Lange Money Hour in two weeks on Wednesday, November 28th, when our guest will be John C. Bogle, founder and long-time CEO of the Vanguard Group, the world’s largest index and mutual fund company. This is David Bear.
James Lange, CPA
Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania. He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again. He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans. Jim’s advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger’s Retirement Reports and The Tax Adviser (AICPA). Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.