Ask the Experts
Q: Why should an estate plan be linked with a business succession plan?
A: "Many business owners don't understand the importance of tying their
business plan into their estate plan," says Maria E. Quinn, an attorney
and owner of Maria E. Quinn Co. LPA. "It has to go hand in hand. It's not
just a matter of getting a will and simple trust. You've got to consider, first
of all, do you have a buy-sell agreement? Do you have partners? Can your family
come in and get their inheritance? Can you go through probate? You could end
up with a business where no one knows who's going to run it, the estate taxes
are due, and the business has to be sold."
Q: What are some of the issues besides taxes to consider with estate planning?
A: "Taxes should be at the tail end of all estate planning," says Thomas P. Rudibaugh, tax partner, Grant Thornton LLP. "A thorough process requires the individual to complete an analysis of personal needs, family needs, and charitable inclination. One must make certain to protect future cash flow requirements to cover unforeseen health needs for themselves and their spouse, as well as managing day-to-day living expenses. The family needs center on protecting the future of children and other family and friends where appropriate. An individual will normally focus on protecting the future education costs of all children, grandchildren, and, in many cases, nieces and nephews. Furthermore, special assistance needs must also be considered for family in all living generations, and potentially generations not yet born."
Q: How do I know when to exercise my stock options?
A: "Many people simply wait until a grant is close to expiration to exercise
their stock options," says James E. Johnson, CFP, vice president, Fifth
Third Wealth Planning Group. "However, there is a better way to analyze
the relative value of different grants. To do so, we first must get a grasp
of the true leverage left in an option. The deeper in the money, the less incremental
change you receive when the stock price goes up, which means the less impact
that specific option grant has in terms of benefit to your net wealth. Conversely,
if you hold on and the stock price drops, the value of the option evaporates
exponentially as you get closer to the strike price. A leverage analysis allows
you to quantify the relative value of option grants, enabling you to plan more
efficiently."
Q: How has tax law changed concerning dividend payments, and should it
alter my investment plan?
A: "The Jobs and Growth Tax Relief Reconciliation Act of 2003 changed
how dividends are taxed," says Tom Hart, financial adviser at Middlefield
Bank. "Under the old tax laws, dividends were taxed as ordinary income.
Now the top federal tax rate on dividend income paid to investors by U.S. and
some qualified foreign companies is generally just 15 percent. This new tax
rate could be a benefit to those looking for income-producing investments. You
should talk with your financial consultant and review your investment plan to
see if the tax law change is a benefit to you." |
Filed away in a drawer somewhere may be your ticket to a small fortune.
There is an exceptional value in unwanted or unnecessary life insurance policies, for both the policyholder and independent investors.
Occasionally, a policy will expire and the insured chooses not to renew it. Or, there may come a time when the insured simply doesn't want or need the policy anymore. Either the insured can stop paying premiums and cancel the coverage or cash it in and receive a surrender value – the amount of money the insurance company is willing to give a policyholder to "return" or surrender the policy.
Life insurance policy owners now have a third option – selling their policies to an investor for more than the cash-surrender value. In return, the buyer takes over the premium payments and eventually collects the proceeds when the original owner dies – profiting if the seller dies before the buyer has paid more than the payout is worth.
This alternative of brokering insurance policies is a big opportunity, for both the investors purchasing the policies and the consumers selling them, says Jim Cavoli Jr., CEO of Life Settlement Insights (LSI), a Cleveland-based brokerage firm that handles life settlement transactions. But some financial advisers say the practice is risky for both buyer and seller, with the potential for fraud or failure.
How It Works
Essentially, life settlement is the process of valuing a life insurance policy while a person is still alive, says Trevor Royston, a partner at Plante & Moran PLLC in Michigan.
Life insurance policies are simply contracts between an insurance company and the insured, stating that the insured will make payments until his death in exchange for a payout at the end to certain people named in the contract. Just like bonds or mortgages, these contracts can be bought and sold.
"We think about $150 billion a year of life insurance could be sold, out of about $1.5 trillion per year of life insurance that cancels," Cavoli says. "We have already shopped $24 million worth of policies and sold about 35 percent of that."
The process generally takes four to six weeks from the submission of an application to the presentation of an offer.
The insured fills out an application with a life settlement brokerage firm, like LSI. The insurance company verifies the policy and the insured's physician verifies the medical history. The application is then reviewed and evaluated by insurance and medical specialists. The life settlement company then provides this information to multiple funding sources, seeking the best offer. The insured reviews any bids and negotiates if necessary.
Once an offer is accepted, forms are submitted to the life insurance company
regarding the transfer of the policy, and the insured receives payment usually
within 24 to 72 hours after the transfer is verified. The closing process is
similar to a real estate transaction.
Reasons to Sell
Life settlement makes sense when a change in circumstance negates the need for the original life insurance policy.
For example, when two people own a business together and create a buy-sell agreement covered by an insurance policy that enables one partner to buy out the other using the payout money if the other partner dies, that policy is no longer needed if the company goes out of business. Or perhaps both partners reach retirement age and instead can use the proceeds as part of their retirement packages.
Another example is a life insurance policy purchased for estate protection or family protection. "[If] I'm a 40-year-old entrepreneur with a wife and young children, I want to make sure if anything happens to me that my family is taken care of and my children can get college educations," says Tom Strau-chon, senior financial planner with Akron-based Sequoia Financial Group LLC. "When I'm 60, I may no longer have a need for that coverage."
John, the CEO and president of a small, private, family-owned manufacturing business in Cleveland, recently sold an obsolete life insurance policy in the life settlement marketplace. Instead of a cash-surrender value of $3,500, John – who requested his last name not be used for this story – and his wife will net (after taxes and fees) just over $194,000 from the sale of their policy.
Originally taken out to cover estate taxes if John's in-laws died while transferring the family business to him and his wife, the policy was no longer necessary once the transaction was completed in December 2003.
John and his wife paid out roughly $20,000 in premium payments over seven years. The couple could let the life insurance policy lapse, continue to pay on it, cash it in, or sell it in a life settlement transaction.
Since it was a survivorship policy, the million-dollar policy would not pay out until both parties died. John would need permission from the insured, in this case his wife's father and stepmother, to place it on the life settlement market. They agreed.
"It worked out great," John says. "We had the insurance coverage during the period we needed it, and now it turned out to actually be a good investment."
Other reasons for selling include poor health or a life change that requires
an immediate influx of cash. Those diagnosed with a terminal illness may cash
in on their life insurance policies before death to pay for expensive medical
treatment or to enjoy retirement immediately.
Life Settlement Candidates
Typically, life settlement candidates are people older than 65 who have secured substantial wealth over their lifetime.
Life settlement transactions often involve those with shorter-than-average life expectancies (less than 12 years to live) with policies worth at least $500,000.
"The challenge is that the secondary market rewards the people who are on the short end of the mortality curve," Cavoli says. "Life settlements apply to maybe 20 percent of seniors."
No one would invest in the policy of a 30-year-old marathon runner who probably won't die anytime soon, he adds.
Policies that are desirable to buyers are at least 2 years old and noncontestable. They should have low yearly premiums – generally under 5 percent of the policy's face value – and generate a return fairly soon. Investors also want to work with life insurance carriers that are rated B+ or better.
Qualifying policies include term, whole life, universal life, joint-survivorship, group, corporate-owned, key-man, and life policies held in irrevocable life insurance trusts.
Mixed Messages
The broker-dealer community is divided on life settlement.
Richard Tanner used to work for a family-owned financial broker that allowed life settlements. He's seen how life settlement can uplift a family after selling a policy for two or three times its cash-surrender value.
Today, as president of Ownership Advisors Inc., an Independence-based wealth and financial counseling firm, he cannot even discuss that option with his clients. The broker he represents won't allow it.
The reason some broker-dealers won't allow representatives to conduct life settlement transactions is the potential for fraud and abuse, Tanner says.
People could lie about their health, leaving the investor to make insurance payments for several more years than planned. Or, even if the seller is ill, he or she may live longer than expected. Dishonest brokers may sell the same policy to many different investors, or the insurance policy could be fraudulent and the insurance company will later refuse payment.
But recently the North American Securities Administration Association Inc. issued guidelines for the sale of life insurance policies to help mitigate abuse. The National Association of Investors Corp. has also developed multiple policies.
There are risks for the sellers, too.
"I don't think it's something people ought to be rushing to do unless their circumstances have changed drastically," Royston says.
Because life settlements are taxable income for the seller, it's not always the best choice, especially for the terminally ill. Insurance companies offer options such as accelerated death benefits to eligible clients, enabling a person to receive some or all of their death benefits (tax-free) before they die.
Selling a life insurance policy on the open market comes down to a personal
decision, one that needs to be made with the help of a trusted financial or
estate-planning adviser after careful consideration of all options. Distasteful
or not, it does appear the life settlement market is poised to become a significant
financial alternative for life insurance policyholders.