Has Your Life Insurance Plan Been Reviewed Recently? 
The Benefits Could be Enormous:

Larry Cavalena, Registered Principal
Raymond James Financial Services, Inc
Member FINRA/SIPC

Life Insurance.  Life insurance protection, like death and dying, is a subject that no one wants to discuss; nevertheless, it represents the foundation of a well-rounded financial plan.

In simplest terms, a life insurance death benefit is nothing more than cash delivered at death.  One advisor described life insurance as the only asset delivered to the widow that arrives “untaxed, untouched and on time”.  That cash, properly invested, can provide income to family members and loved ones when they need it most, at the premature death of a family bread winner, and for the rest of their lives.  In addition to being a source of income, it can provide liquidity to pay taxes and expenses at the time of death.  For closely held business owners and professionals, life insurance can convert an illiquid, unmarketable ownership interest into a pool of cash that will support the lifestyle of the deceased’s family indefinitely.

Life insurance, like a managed investment portfolio, responds best when it receives occasional care and review.  Unfortunately, many people pay little or no attention to their life insurance following the purchase.  Policies are locked away in the family safe deposit box and never emerge until someone dies.  Likewise, annual statements are filed without so much as a glance, or simply thrown away.

Insurance mistakes can be costly.  Any of the mistakes or issues discussed below can result in death benefits going to the wrong person, or result in unexpected taxes.  Fortunately, each could have been easily avoided, or, if found in time, corrected quickly and inexpensively.

Years of experience have shown that two sets of circumstances can cause difficulties with a life insurance portfolio.  First, the insurance may not have been set up properly when it was purchased.  Secondly, the passage of time and changing circumstances may dictate that modifications in the ownership, beneficiaries, the type or amount of insurance should now be considered.

Life Insurance Ownership.  For individuals who will never be subject to federal estate taxes, owning a policy on one’s own life may not be a problem; however, if there is any likelihood that the estate of the owner/insured may exceed that exclusion amount ($2,000,000 in 2008, but will revert to $1,000,000 in 2011), your estate – including your life insurance  -- may be subject to federal estate taxes as high as 55%.*  Personal ownership of your life insurance under these circumstances can be very expensive.

*Congress is likely to amend the estate tax law prior to 2011.

Beneficiary Designations.  The importance of naming the beneficiary of a life insurance policy is self evident.  Surprisingly, mistakes in naming beneficiaries are quite common. 
Often, the estate is named as the beneficiary.  In many states, death benefits paid to the estate will be subject to unnecessary state inheritance taxes.  Likewise, if a named
beneficiary has previously died, or if no beneficiary is named, the estate becomes the beneficiary by default.  In either case, the death benefit may also be subject to state inheritance taxes.  Death benefits paid to an estate will also be fully accessible to creditors of the insured.  The proceeds would in most cases also be subject to the delays and expense of probate.

Another serious problem may arise if minor children or grandchildren are named beneficiaries outright.  This could subject the proceeds to expensive and lengthy court proceedings to appoint a guardian or custodian to receive, manage and distribute the proceeds.  Similar problems may arise if the beneficiary is physically or mentally impaired, and unable to manage his or her own affairs.

In all cases contingent beneficiaries should be named in the event that the primary beneficiary predeceases the insured.

Review Every 3 Years.  As a part of your regular financial checkup, your life insurance portfolio should be reviewed every 3 years.  Failure to check policies every three years results in more issues than any other factor.  All too often, the named beneficiaries no longer reflect the desires of the owner.  Former spouses remain on the policy, while current spouses are not named.  Children who were born after the policy was issued have not been added.  Beneficiaries who have died after the policy was issued remain on the policy.  Leaving your insurance to your children “equally” may no longer fit family circumstances. Old beneficiary designations may be in conflict with trust provisions. Any of these situations can ruin an otherwise well thought out financial plan.

Inadequate coverage.  It is difficult to tell the true cost of maintaining the lifestyle of a surviving spouse, children and sometimes grandchildren.  Food, clothing, shelter, college and graduate school can amount to hundreds of thousands of dollars.  Are there any special needs which must be funded?  Has your personal financial situation changed due to fluctuations in the stock market and real estate market?  Have changes in employment or changes in the family situation altered your need for life insurance?  The effects of inflation can erode the value of life insurance protection purchased years ago.  As individuals grow older, many feel that life insurance is no longer needed.  Many also find that they may still need to assist grown children or they become responsible for aging parents.  Leaving a lasting legacy to a favorite charity or institution becomes important.  Any of these factors could change the amount of life insurance needed.

Contrary to popular belief, the Federal Estate Tax is not dead.  The extraordinary financial obligations of the federal government for Medicare, Medicaid and Social Security, as well as other general demands on the government treasury, make it likely that tax rates of all sorts will be climbing, not declining.  Many families may be surprised to find that their inheritance is subject to federal estate taxes, as well as substantial state inheritance taxes.

Unnecessary or Non-Cost Effective Coverage.  Just as inadequate insurance or incorrect policy type can be expensive, over insuring or non-competitive rates on current policies can also be costly.

In some cases, the original circumstances that require the purchase of life insurance may no longer exist.  Old permanent insurance policies may have very low internal rates of return and may not be cost effective.

Term insurance rates are very competitive.  In many cases, especially for healthier individuals, current term insurance rates may be lower than the rates built into the existing policy.

Type of Insurance.  Today, life insurance comes in many forms. Short term financial needs can be solved with term insurance.  Longer term, or needs of uncertain duration, may require permanent coverage or a combination of permanent and term coverage.  Survivorship insurance may be the preferred method to pay taxes at the second death.

It is important to fully understand the provisions of your term insurance.  How long does the premium stay level?  Is it guaranteed?  How much does it increase after the level premium period has expired?

Longer term needs should be met with permanent insurance.  When the duration of the need is unknown, permanent insurance or a combination of term and permanent should be considered.

The lowest cost insurance may not always be “inexpensive”.  Insurance which has a low cost but does not accomplish the objective may not truly be the “inexpensive” choice.  For permanent needs, such as estate tax payments, funding surviving spouse retirement, children’s special needs, higher cost permanent insurance is really the most “inexpensive”, cost effective choice.  Survivorship insurance, which insures both a husband and wife, in many cases may be the least expensive way to pay estate tax costs.

Business Insurance and Buy-Sell Agreement.  As with personal insurance, business-owned insurance may not have been reviewed in years.  It is imperative that business owned life insurance should be reviewed periodically.  Many of the questions relating to personal insurance apply to business-owned life insurance.  Additional questions specific to the business will arise:  How does the insurance impact the owner’s personal financial and estate plan?  What is the value of the business?  How is the business valuation determined and how long since it has been updated?  What type of agreement is it?  Cross purchase?  Wait-and-See?

Business-Owned Insurance Payable to Personal Beneficiary.  Businesses often purchase insurance on the owners for personal purposes.  When the third party beneficiary (spouse, co-shareholder, creditor) receives the proceeds, they may be subject to ordinary income tax unless proper precautions have been taken.

Policy Performance.  Finally, existing policies should be evaluated to confirm that they are performing as projected at purchase.  The death benefit of certain policies is dependent on current interest rates.  These policies should be reviewed periodically to evaluate performance.  Trust-owned policies are particularly susceptible to neglect and performance issues.

 Each of these situations could have potentially serious consequences.  In addition, each could have been easily avoided, or, if found in time, corrected quickly and inexpensively.

Have your life insurance portfolio evaluated from an impartial, holistic perspective.  Start with an assessment of your insurance needs, focusing on survivor income, inheritance taxes and other final expenses.  Review policy ownership, beneficiary designations, cost and performance of existing policies.  A little time invested may produce substantial rewards.

Your questions and comments are welcome.  Larry Cavalena can be reached at Larry.Cavalena@RaymondJames.com.

1006 N. Wooster Ave
Dover, Ohio  44622
330-343-2212

Please note, changes in estate planning laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the estate planning provisions of the issues presented herein, as Financial Advisors of Raymond James Financial Services we are not qualified to render advice on tax or legal matters.  You should discuss any tax or legal matters with the appropriate professional.