Natalie A. Roberts, J.D., LL.M.
Natalie A. Roberts, J.D., LL.M.

For Financial Advisors, Trust Officers and CPAs: The Importance of Reviewing Existing Life Insurance Policies with your Clients

How long has it been since your clients have reviewed their existing life insurance policies? Trust officers, financial advisors, and CPAs should audit their clients’ life insurance policies. Experts are warning that a significant percentage of life insurance policies will fail before the death of the insured.

Clients who purchased policies with less expensive premiums may discover that their policies were underfunded. And with interest rates declining over the last years, a significant number of policies have underperformed. By calling in insurance agents and working as a team, each client’s situation can be reviewed and evaluated. If a client’s policy is producing disappointing returns, one solution could be additional funding of the policy.

Life Insurance Trusts

Many high-net-worth clients have irrevocable life insurance trusts (ILITs) in place. Those clients should not only review the policies held inside the trusts, but should also review the trusts. When commencing a review of existing ILITs, the first task is verifying that the trustee is observing the necessary formalities of administration. Questions to ask include: Is the trustee supposed to be issuing annual Crummey Letters? If so, is the trustee continuing to do so? Is the policy properly titled in the name of the trust? What are the terms of the trust agreement, the operating instrument for the trust? ILITs were originally created to remove assets from a client’s estate in order to minimize estate tax at the death of the client.

In the 1990s, estate tax exemptions were as low as $600,000. In 2016, the estate tax exclusion amount was $5.45 million per individual and $11 million per couple. As a result of the 2017 Tax Cuts and Jobs Act, however, the estate tax exemption amounts doubled to $11.4 million per individual and $22.8 million per couple. With many clients no longer currently facing estate tax exposure, some clients may question whether they need their insurance policy or trust. Clients should be reminded that the higher exclusion amounts will automatically sunset in 2026. Furthermore, the estate tax laws relating to exemption amounts could change at any time, especially with a change in control of the Senate or the Presidency. Most importantly, ILITs created for estate tax minimization can be repurposed.

Existing ILITs may contain outdated provisions. Typically, these insurance trusts were set up to distribute the funds out of the trust to the beneficiaries when the beneficiaries reached a certain age. Today, most planners are recommending and creating perpetual trusts (also called dynasty trusts or cascading trusts). The good news is that existing ILITs can be decanted or non-judicially modified (by consent of the beneficiaries) to a new, more robust trust so the trust will continue for multiple generations. At the same time, these newer trusts will protect the life insurance proceeds and other trust assets from beneficiaries’ creditors, predators and divorcing spouses. For very high net worth clients, decanting or modifying an existing ILIT can provide the opportunity to lock in planning using the current high exemption amounts, before the opportunity is lost.

For many reasons, life insurance policies typically should not be allowed to lapse. First, the client could become uninsurable due to age or medical issues, so maintaining existing policies could be a necessity. Secondly, insurance policies may have significant cash value and can serve as a conservative savings vehicle, alongside bonds and other fixed return investments.  And, finally, the proceeds of a policy bought for one purpose can be redirected to a different purpose. For example, funds paid out on an existing policy can be used to pay income tax on assets that will not receive a step-up in basis because the assets were originally transferred to an irrevocable trust.

A popular planning technique today is the spousal lifetime asset trust (“SLAT”). This kind of trust provides income for the beneficiary spouse for life, with the assets going to the children upon the beneficiary spouse’s death. The settlor-spouse can presumably access the trust assets indirectly through the beneficiary-spouse.

But what is the beneficiary-spouse dies, and the settlor’s indirect access to trust funds is cut off? Premature-death-of-a-spouse insurance is a great way to provide protection to the settlor-spouse if the beneficiary-spouse dies prematurely. Moreover, some practitioners are adding separate life insurance trustees and insurance powers to SLATs and other irrevocable trusts. That way, SLATs can constitute more robust ILITs.

An existing ILIT can sell its insurance policies to newly-created SLATs or other irrevocable trusts that have additional assets generating income to pay the insurance premiums. This simplifies insurance planning and trust administration. 

With a new client, financial advisors and CPAs can offer an insurance policy audit.  Assemble a spreadsheet showing each policy and each policy’s owner, beneficiaries, death benefit, premium, cash value and whether there are any loans against the policy. The audit can reveal a need for additional planning.

By working together with CPAs, financial advisors, estate planning attorneys, trust officers, and other experts, clients will benefit from a high level of expertise and creativity to optimize opportunities.

[1] The author relied heavily on the ideas and information provided
by Lee Slavutin, an estate planning and life insurance expert, and Martin
Shenkman J.D., MBA, CPA, an estate planning attorney, in a webinar entitled
Life Insurance Planning after TCJA, Appreciation for their ideas and
explanation is hereby expressed.
Natalie A. Roberts, J.D., LL.M.

Natalie A. Roberts, J.D., LL.M.

Natalie Roberts is licensed to practice in both Florida and Minnesota. She is dedicated to providing honest, exceptional and deeply personalized legal counsel to her clients.

Share this post