ILITs Offer a Huge Opportunity Many Advisors Miss
Subscriber Benefit
As a subscriber you can listen to articles at work, in the car, or while you work out. Subscribe NowMany advisors use irrevocable life insurance trusts as a means to best handle their clients’ money and to ensure that the families of their clients are taken great care of in the event of the client’s death. But many trusted advisors are missing one huge opportunity in life insurance trusts, and it’s right under their noses.
By managing future estate taxes, you’re saving the family potentially hundreds of thousands of dollars that can have a big impact for them in the future.
Often, life insurance policies simply underperform. And in ILITs, investable capital can get tied up by simply paying the premiums for these policies – especially if the premiums have increased over time, as many of them do.
Changes in estate taxes have also had an impact on the worth of policies in ILITs. The American Tax Payer Relief Act of 2012, for example, raised the estate tax exclusion to $5.25 million. That amount has increased in 2016 to $5.45 million. This saves the majority of American households from the burden of the estate tax, making ILITs a little less necessary than before.
When you consider interest rates as well, life insurance policies aren’t raking in the amounts they could have been. The historically low rates dropped the earning potential on many policies to well below numbers that could be considered good returns. And even though the Fed is set to boost the insurance rate for the first time in years, it may still be quite a while before we see them get back to a rate that means good news for life insurance investments.
As the trustee of an ILIT, it’s your job to review the trust for asset performance. But in these reviews, many advisors simply look at the policy, see that the policy is doing well enough—not great, but not particularly bad, either—and let it continue on. In most cases, they completely overlook opportunities to turn life insurance policies into liquidity, allowing for more flexible investments to better suit the beneficiaries of the trust.
In an ILIT, you can still sell an underperforming life insurance policy in a life settlement. A life settlement is the sale of a person’s life insurance policy to a third-party investor. In a life settlement, the policy’s owner transfers the ownership of that policy in exchange for an immediate cash payment from the buyer. Candidates for life settlements are typically 70 or older, with a life insurance policy that has a "face value" (death benefit) of more than $100,000.
By selling the underperforming policy, you’re opening up an opportunity to invest in other, more lucrative opportunities, providing a higher performing trust for the beneficiaries.
How big of a difference can selling a life insurance policy out of an ILIT make? Let’s look at an example. Ms. Williams, an 84-year old woman, had a $1.6 million universal life policy held in an ILIT that she originally purchased for Federal estate tax purposes. But because of some of the aforementioned changes in estate tax laws, she no longer needed that policy. Ms. Williams made the decision to no longer fund the premiums and the policy had a cash surrender value of $78,560.
Ms. Williams discussed options with her lawyer and the trustee, and it was determined that a life settlement would make the most sense. The trustee and Ms. Williams retained the services of a life settlement expert and they were able to solicit multiple bids from a variety of funders.
In a little over two months, a top offer of $428,000 was made for the policy and was accepted by the trustee for Ms. William’s life insurance policy.
Obviously, cases will all differ drastically, but as you can see from the example above, a life settlement can take a life insurance policy that is not performing as well as it might be and provide you with a significant amount of cash that can be used to fund other investments—or be used in any other way that’s seen fit.
ILITs may still be a viable tool in many cases, but it’s best to not let the proposed benefits of an ILIT blind you to other, far more lucrative options available to you. Find the solution that works best for you. In some cases, that may very well be a life settlement.
Leo LaGrotte is chief executive officer of Life Settlement Advisors.