Affluent families and individuals, successful business owners, and those engaged in certain occupations, such as the medical or construction industry, all face similar challenges when choosing to invest: They have worked hard to accumulate wealth, and now they want to keep it.
Wealthy investors are driven by the same concerns:
Preservation: Given the choice between risky strategies or preserving what they have, most affluent investors will choose to preserve what they have.
Liquidity: Without access to your money, wealth may not be maximized.
Protection from creditors and frivolous lawsuits: The legal risk posed to affluent investors in today’s society is extraordinary.
Control: Affluent investors value the flexibility that allows them to respond to changes in their personal and business lives.
Taxes: Although we can’t be certain that taxes will go up, the odds suggest they will — perhaps significantly so. Mitigating the bite of the tax man is a top priority for wealthy investors.
To address these concerns, affluent investors and their advisers have many investments to choose from, such as IRA and Roth IRAs, equities and mutual funds, tax-advantaged bonds, annuities and personally owned life insurance (POLI), to name a few. Each of these investments has advantages and disadvantages when addressing the concerns of affluent investors. But what is POLI? To answer this question, we need to look at life insurance in an entirely different way.
Getting the most out of your investment type
What if instead of shopping for the most death benefit for our premium payment dollars, we sought out the federal minimum required death benefit in our policy to keep our insurance costs low and our investment value high? What if we created a “sinking fund” by investing in personally owned life insurance to create a tax-advantaged retirement supplement plan, and much more?
People often don’t recognize the value of permanent life insurance as an asset in their portfolios. Cash value life insurance offers much more than simple death protection.
Consider the following asset characteristics:
Qualified plan and annuity assets, in addition to being included in the taxable estate of an owner, are also subject to income in respect of decedent (IRD) at death. Seventy percent is an estimate of the combined impact of estate and IRD taxes, as well as credits given in the high net-worth decedent’s estate. The number can be higher or lower depending on the applicable marginal brackets.
Death benefits of a life insurance policy are generally received income tax-free by the owner of the policy. In order to avoid estate inclusion, the death benefit must be received outside the estate, often by designating the “B” Trust as the contingent owner and beneficiary of a policy owned by a decedent. Certain types of split dollar and loan transactions used in conjunction with an irrevocable life insurance trust (ILIT) also can be used to exclude the death benefit from estate inclusion. These techniques may involve gift tax implications, such as using a portion of the annual gift tax exclusions.
The benefits of POLI
Structured properly, POLI allow unlimited contributions, tax-deferred accumulation, tax-free redistribution, tax-free withdrawals, total liquidity, no income or estate tax at death, and the possibility of asset protection. This is an extraordinary combination of benefits.
Put simply, when structured properly the investor retains control of all the assets in a POLI account, including the right to terminate the account and withdrawal of the cash value. There is nothing “irrevocable” about a properly structured POLI contract. POLI, when properly structured, allows for nearly unlimited withdrawals after the first year at rates between 1 percent and 0 percent.
Using POLI, unlimited after-tax deposits may be made by the investor to be deployed in the equity and fixed income markets in almost any combination. An additional benefit is that in many states, the assets in POLIs are creditor protected. Asset protection against the creditors of an insurance-based contract owner is a matter of state law. Some states offer no protection for annuities life insurance cash value, some offer some protection for a portion, and others offer complete protection (check with local counsel to determine the applicability of asset protection in a given jurisdiction). Finally, assets invested in POLI are removed from the investor’s estate, while still providing the investor control of the assets.
Life insurance: A cautionary note
Of course, federal tax law definition of “life insurance” limits your ability to pay certain high levels of premiums. In addition, if the cumulative premium payments exceed certain amounts specified under the Internal Revenue Code (IRC), your policy will become a Modified Endowment Contract (MEC). If your policy is a MEC, many benefits of POLI are removed.
An “optimized” life insurance policy involves several elements. First, the contract should pass one of two tests for the definition of life insurance, thus avoiding status as a MEC under IRC 72, which generally limits the amount of cash value or contributions relative to the amount of death benefit. To exceed these limits causes distributions to be taxable. Second, in order to avoid estate inclusions, the death benefit must be owned outside the estate.
These are highly sophisticated and complex investments, and you should discuss whether a POLI is right for you with a knowledgeable team of financial, legal and tax professionals.