Life Insurance and a Legacy Floor

For most of your clients, especially those below the $5 million exemption, the language and positioning of planning is all changing

by Randy Zipse, JD, AEP and Brett W. Berg, JD, LLM, CLU, ChFC

With the increase in the federal estate tax exemption to over $5 million per person and $10 million for married couples, many life insurance agents and financial advisors are seeking creative ways to help customers understand how life insurance is still relevant to their planning.

Changing Needs

After all, when the federal estate tax exemption was $1 million, many life insurance agents didn’t look past funding for the estate tax liability as a strategy with their clients. The life insurance “need” on nearly all permanent life insurance sales was seen as estate tax liability protection or for general “estate planning.”

For most clients, especially those with less than $5 million in assets, and their advisors, the language is changing, the positioning is changing and the approach to selling life insurance is changing.

In general, for clients with less than $5 million, legacy planning is a popular overall topic. Making life insurance relevant and important in legacy planning is central to success in ensuring clients secure appropriate coverage. One way to position life insurance in the context of legacy planning is to consider how life insurance can help clients create a legacy floor. Creating a legacy floor is simply another way of articulating the primary purpose of life insurance – to protect a client’s legacy plan against the risk of early death.

The basic idea of a legacy floor is to reposition a portion of the assets already set aside for the intended legacy (“legacy portfolio”). Purchasing life insurance to help establish a baseline amount, ensures client’s beneficiaries are paid the benefit provided the policy is in effect at the time of death.

Target: High Net Worth

For those clients with sufficient net worth and annual income and/or those who do not need a portion of their assets for retirement income, this strategy can make sense.

Of course, life insurance contracts vary in terms of the benefits and features, cost and expenses, amount of death benefit and crediting methods with respect to the policy’s cash value. Actual death benefit and other benefits depend upon age, health and premium amount among other factors.

Anyone considering this strategy should carefully consider the specific life insurance features and benefits being purchased in light of their overall planning needs and objectives. It’s also prudent to consult with a financial advisor and/or tax advisor prior to implementing this strategy.

In general this strategy may be most appropriate for people who:

• Are at least age 59 ½ + and family oriented
• Have sufficient net worth and liquid assets to support this strategy
• Hold assets not needed to support financial goals in retirement
• Have sufficient retirement income from other sources, besides the assets being repositioned
• Have a financial plan completed by a financial advisor
• Have a desire to provide a legacy for children, grandchildren, and/or charity

Case Study

For example, John is 60 years old. He is reaching retirement age and has accumulated $5 million in assets.

After looking at his retirement needs, he has ear-marked $2.5 million of his current assets for his heirs. Assuming what John expects in terms of investment returns, he hopes that he can grow his projected legacy from $2.5 million to $4.5 million.

Like many clients, John may be considering how long he’ll live and think he has plenty of time to grow his portfolio. In fact, according to the 2010 Social Security tables, 60 year old males generally have a 21 year life expectancy, which means John can expect to live until the age of 81.

If he does, John may have a reasonable opportunity to potentially grow his portfolio to his target – $4.5 million. However, we know that not everyone lives to their life expectancy. Some people live beyond life expectancy and some people die before life expectancy.

In this case, dying too soon is a key risk for John to protect against when planning. John’s agent has discussed the idea of using life insurance to help John create a legacy floor. In John’s case, he anticipates growing his “savings” during the remainder of his lifetime to leave as a legacy to his heirs.

What could derail his plan? John could not achieve his desired or expected growth rates on his assets for many reasons, including investment performance or simply an inopportune economic collapse. But, the biggest risk to John reaching his legacy goal is early death.

Using a modest portion of his current legacy portfolio, John can pay premiums for a life insurance policy to help protect his legacy. John has identified a $2.5 million portion of his assets as true legacy portfolio. In other words, John does not anticipate needing these funds during his lifetime.

Life insurance can help John protect his legacy plan and protect his heirs against the risk of him dying too soon. Depending upon the insurance carrier, at age 60, a healthy male may be able to purchase $2 million of permanent life insurance for approximately 1% of the $2.5 million legacy portfolio per year (i.e., $25,000 per year).

By purchasing the life insurance, John has created a legacy floor to protect his intentions for his heirs in the event he died. In conclusion, the strategy of using life insurance to help ensure a legacy is well established. By positioning the idea in new ways, you can help clients understand how life insurance remains extremely relevant to their overall planning.

Helping clients understand how life insurance may help them create and maintain a legacy floor is one way to communicate the power and value of life insurance in today’s planning environment. ♦

Life insurance is issued by The Prudential Insurance Company of America, Newark, NJ, and its affiliates.