What are the mechanics of this strategy
An estate transfer sometimes called an estate bond is a financial planning strategy that can maximize the value of your estate by either reducing the amount of tax and/or the amount of risk your client would have had to take on to achieve the same net estate value. It works by shifting a defined amount of money from a tax-exposed investment (think non-registered retirement savings plan) to a permanent life insurance policy (Universal Life or Whole Life Policy).
An insurance policy offers protection right out of the gate however there can also be an "investment" component that accumulates inside the policy on a tax-advantaged basis (Section 148 of the Income Tax Act).
This tax sheltering provides this strategy with a compelling advantage when compared to traditional assets that can be subject to double taxation (tax on growth and on death/withdrawal). Essentially when you die, the beneficiary receives the proceeds however due to the tax-sheltered growth the net estate benefit is much larger and the capital invested to achieve that net benefit is much lower, in other words, it has a greater capital efficiency & you can access the cash value while you are living.
Who is this strategy for
No matter what you call this strategy it is targeted at the HNW, Affluent/Super Affluent & corporate market. This strategy works for corporations and individuals who have excess income or assets that are not needed to fund their current business, lifestyle, or their retirement.
Corporate Estate Transfer
For corporations, the corporation purchases a whole life or universal life insurance policy insuring the life of the shareholder. The corporation owns the policy, pays the premiums, and names itself as the beneficiary. Premiums are paid by transferring assets subject to income tax from the investment portfolio to the insurance policy. The cash value grows within the life insurance policy on a tax-advantaged basis. Depending on the insurance vehicle used the insurance benefit can increase as well. When the insured person dies, the life insurance death benefit is paid tax-free to the corporation as the beneficiary via the Capital Dividend Account (CDA = Total Insurance Benefit - Adjusted Cost Basis). The CDA credit can then be used to pay tax-free capital dividends out of the corporation to the estate or shareholders. Please note you should work with your clients' tax advisor as transferring assets from their investment portfolio to pay the life insurance premiums may trigger deferred capital gains.
Personal Estate Transfer
For individuals the process has less moving parts, your client would purchase the policy and the total insurance benefit is paid to the beneficiary tax-free, however, the net estate benefit is still maximized due to the elimination of double taxation vs non-registered assets.
what are the benefits
There are many benefits of this strategy, perhaps the most important is the capital efficiency that can be achieved by using life insurance vs a traditional asset that could be subject to multiple layers of taxation. Life insurance funds a liability at a lower cost. Sometimes the liability is a tax liability that is created from financial success. Many would consider this a good problem but a problem that has a unique solution. Keeping more of your hard-earned money is always a great benefit.
A key benefit is that this strategy is that it often kills two birds with one stone, meaning the same clients who need to reduce tax and operate companies also generally need an abundance of life insurance. Business owners are famously underinsured however love to keep more of their hard-earned money, if this strategy helps them get there, consider it a win-win.
Another potential benefit is portfolio diversification. Many advisors speak to having this strategy represent the "safe money" part of their clients' portfolio. Unlike most other one-dimensional safe money investments, life insurance offers the opportunity to play it safe and have an almost unlimited number of investment options inside a universal life policy or have the unique benefits of the whole life participating fund, generally consisting of a mix of bonds, real estate, equities and mortgages.
High Net worth clients value privacy, insurance offers enhanced privacy as proceeds of an insurance policy are not subject to probate and thereby won't become a matter of public record.
People want to be able to access their money if something unexpected or once in a lifetime comes up. The ability to take a policy loan, collateralize the policy to a third party lender (bank) or take a policy withdrawal is a huge appeal. One caution is that clients often have skepticism when something sounds too good to be true. My stepfather would often tell a story about how a certain Toronto telecom mogul would ring up Canada's life to borrow a million dollars (tax-free) from his par policy to fund a once in a lifetime opportunity and then he would put the money back after.
what are the risks
There are of course risks with any financial strategy, as there are many assumptions that are used, such as dividend scale or rate of return, even the tax assumptions made are
likely going to change. LDA can help you you analyze various scenarios to ensure net estate value efficiency is still achieved even with lower than expected returns. Many of these same risk factors are equally present in any other asset class, however, insurance as an asset class is still considered "safe money" because there is a guaranteed insurance component (often guaranteed cash value as well). It will still be very important to document how you determined suitability and came to your product & carrier decision.
Although we also list this as a benefit, its worth noting liquidity as a perceived risk too. The worry from clients is that the money invested in an insurance policy is not liquid. As we mentioned in the benefits paragraph there are several ways to access the cash value of an insurance policy however not all of these methods to withdraw cash from a policy are without consequence. For example, although you could take a policy loan (often 90% + of CSV) the loan may mean you are accruing interest inside of the policy (often at 5%) that can impact future values. Make sure your clients have a realistic expectation of how this kind of liquidity can be accessed and what is required to execute the desired strategy.
Another potential risk is getting locked into a payment schedule, this may not be as big an issue if a universal life policy where the premium can be reduced to the minimum funding level, however, if a whole life policy is selected and the client or corporation has issues paying the premiums in the future, it may impact the efficacy of this strategy. There are some safety nets such as auto policy loan (APL) although again these are not without consequence and can impact future values or even potentially put the policy at risk of lapse depending on how mature the policy is. However, generally, this strategy is for people looking to minimize taxation caused by excess wealth, so it's not often a concern if the client is a lock for this strategy but be sure to document the facts of the case in your reason why letter and try to bring in your clients tax consultant early in the sales process.
Phil is the owner of a thriving dental practice. He is 40 years old and in good health with 2 kids about to start university. The business has expanded and has more assets than it needs to operate many of these assets are exposed to a high rate of corporate tax. Phil is approached by his advisor who suggests he should consider moving those assets from account A where it is exposed to tax to account B. Account B happens to be a guaranteed 20 pay participating whole life insurance policy owned and paid for by his corp. They determine they can move $50,000 a year for the next 20 years($1,000,000 total deposits). Phil's advisor uses this report to highlight the flow of this strategy and illustrate the capital efficiency of a life insurance policy. The result is a net estate benefit of 238% or roughly $5 Million Dollars! The supplemental bonus, Phil now has permanent coverage in place for when his existing term ten policy hits its renewal in 9 months.
how to present this solution to clients
This is an extremely powerful solution however as with anything, it does not mean much if we can't communicate that value to our clients. Advisors who successfully execute this strategy are successful for a few reasons:
- They highlight the flaws of the traditional method vs. the proposed strategy.
- They prove the numbers
- They change their clients' perception of what life insurance is used for or can be used for.
People are more skeptical than ever when it comes to their investments and want to understand from a concept level why this concept works before diving into the numbers.
Even though this is a complicated financial concept we have to make it simple for our clients to see the flow of money (Account A vs Account B). Advisors who are successful with this concept prove both cash flows scenarios and make it easy to see the advantage of using life insurance.
Even if advisors have done both of the above, manny times they need to change their clients perception about what an investment can be. Many clients have a hard time considering life insurance anything but a tool for when you die. The right presentation can help them think about life insurance as a multi purpose tool that can enhance the value of their business or estate.
How to find clients who can benefit from this strategy
Obviously we would all love to have an abundance of HNW and Super HNW clients to select from, however, if you want to find clients in your network this would work to look for existing in-force policies sold to business owners. If you are prospecting think about searching Linkedin for professionals with hold co's or op co's. These are your dentists, doctors, veterinarians, car dealers, entrepreneurs. You might even use a tool like Dux-Soup to scale your efforts and have these types of professionals look back at your profile stocked with information on this concept.
You could even go as far as to set your profile headline to speak to this target audience.
Watch Our Video To See How to present this strategy to clients
Find a more detailed video breakdown of this concept here.
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