Life Insurance policy to transfer wealth

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suewolf
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Life Insurance policy to transfer wealth

Post by suewolf » Mon Jun 11, 2018 7:29 pm

HELP fellow Bogleheads...

Through a combination luck, prudent lifestyle and simple investing, we find ourselves in a position where we will very likely pass a significant sum of money to my kids. Our plan was to die with zero dollars left, having already provided for our sons' debt free college educations. Yet here we are. I count my blessings every day.

Question: Does a second to die life insurance policy make sense?

Background: Both wife and I are 60 years old. When I model our cash flows, I forecast having 5 - 6 MM$ at death (depends on age) if I limit returns to 2 percentage points over inflation (returns of 5% vs inflation of 3%). Even when I try to model a worst case scenario (market crash where my entire portfolio decreases by 15% next year and in 15 years after that, with all other years at 2 points over inflation), I still end up with over 1.5MM$. When I use the Fidelity monte carlo model, my 90% probability case is about 1.5MM$ at time of death (50% probability is 12 MM$ but I think they overestimate the market)

Asset allocation: In my Taxable accounts, I have 75% stocks, 11% Bonds and 15% cash; In my Tax deferred accounts, I have 28% stock and 72% Bonds. This averages out to about 45% stock, 50% bond, 5% cash (mostly in CD's right now). At time of death, my tax deferred accounts will have slightly more than 50% of my assets. And that's the issue since my kids will have to pay tax on these.

Logic of life insurance. When I die, my kids will have to take money out of the tax deferred accounts on a schedule and over time they will pay taxes on these RMD withdrawals. They will also pay a little in PA estate tax (4%). So I view the insurance policy as a transfer of assets. I move approx 24k$/yr from my accounts to the life insurance company. In exchange, when we both die, my kids get 1 MM$ tax free. The alternative of course is to keep my money and invest it. If I assume my kids will be in top 35% tax bracket when I die (they are 30 - 33 years younger than me) , I'd have to make approx 5.5% interest RISK FREE for them to have the same amount as that million dollar life insurance policy if I die at age 90 (5% if I die at age 95). I assume the insurance company bankruptcy is a very low probability.

I don't know of too many risk free investments that will guarantee me 5 - 5.5% over the next 30 years. So it seems to me this is a good deal. My heart is telling me to run from giving an insurance company money but the numbers seem to say DO IT. I dropped my term life insurance years ago when my kids become financially independent. So I've generally been in the Bogelhead insurance haters club. But I have to admit this makes sense to me.

Advice please?

Grt2bOutdoors
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Re: Life Insurance policy to transfer wealth

Post by Grt2bOutdoors » Mon Jun 11, 2018 7:47 pm

You live to age 90, you pay in $720k in principal payments, your heirs get a million in deflated dollars? How is that a “risk free” investment? I don’t see how life insurance is a bargain at that price? If you invested at a conservative 3-4% over 30 years I think you’d beat the $230k after tax returns of life insurance company.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

Nate79
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Re: Life Insurance policy to transfer wealth

Post by Nate79 » Mon Jun 11, 2018 7:58 pm

It is not exactly clear from your post but are you planning on only spending down your tax deferred accounts from now until death? So you leave the taxable accounts to grow, they get a stepped up basis upon death. So those accounts are fine, they will pass directly to your beneficiary tax free. So the only question is if all of this life insurance whole life crap is worth all the trouble for your tax deferred accounts.

As was pointed out first you don't know the risk free return because you don't know when you will die. Second, you are forgetting whatever the return is actually in nominal terms and really isn't that great. $1m 30 years from now may be worth well less than half depending on actual inflation values.

letsgobobby
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Re: Life Insurance policy to transfer wealth

Post by letsgobobby » Mon Jun 11, 2018 8:53 pm

Yes please explain how you are getting a guaranteed 5.5% return.

Wouldn't it be simpler for you to convert your IRAs to Roths and spare your kids any tax at all? It would also reduce their inheritance tax as the estate would be smaller.

Jmo24
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Re: Life Insurance policy to transfer wealth

Post by Jmo24 » Mon Jun 11, 2018 9:14 pm

What age is your policy run out to? For example is it run to age 105, 120. I am an FA and I get wholesalers pushing this strategy on me all the time and I just can’t get behind it for this reason. Most of the second to die life policies are Universal life policies which are just very long “term” policies that are designed to last longer than you do but if you live past the age they are run out to YOUR KIDS GET NOTHING. Ask whoever is reccomending this policy what age it is run out to and what happens if the last of you or your wife to die lives past that. You will be shocked at the answer.

Now they will tell you that you won’t live that long etc, but ask them why the insurance company caps it if that is the case. No one crunches numbers better than actuaries and they cap it for a reason. I guess my point is it is not risk free. My grandfather lived past 100 and died 15 years ago. What do you think they ran policies out to when people were buying them when he would have been age 60? 90, 95? Prolly not any longer than 100.

An easy way to see what age the policy that has been reccomended to you is run out to is to look at the illustration provided to you by the sales person. At some point usually 105 but no later than 120 the death benefit will be $0. 120 is the longest they are run out to but most are only run until 100 or 105 because it lowers the premium. It would be very unlikely one of you live past 120 but one of you could live past 100 or 105. Don’t buy this policy without being fully aware of this.

Also, have you considered spending down your tax deferred account first? Then the taxable account would transfer federal estate tax free (provided you do proper estate planning and have under 22.4 million to pass on) and with a step up in basis (meaning the cap gains will be tax free to kids). If avoiding estate taxes is your primary goal this may be a better route to go. Normally you spend the taxable first if you are worried about running out of money while alive but from your post that doesn’t seem to be a major concern for you.

Also the commission the sales person makes is usually 90% of the first years premium so they really want you to buy it. FYI

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David Jay
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Re: Life Insurance policy to transfer wealth

Post by David Jay » Mon Jun 11, 2018 9:51 pm

You are only one and two years, respectively, younger than us. Do you remember the high inflation of the late 70s? We were trying to buy our first home in 1980 and bank mortgage interest rate was 14% (we couldn’t qualify, we were delighted to get seller-financing at 11%).

What happens to your insurance payout if we get a decade of double-digit inflation? All of a sudden your million bucks has the buying power of about $350,000. And you can’t change course, the policy is illiquid. That is WAY too risky for my taste.

Insurance is virtually never appropriate as an investment (don’t misunderstand me: Insurance as insurance is necessary and appropriate).
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

Grt2bOutdoors
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Re: Life Insurance policy to transfer wealth

Post by Grt2bOutdoors » Tue Jun 12, 2018 7:31 am

Jmo24 wrote:
Mon Jun 11, 2018 9:14 pm
What age is your policy run out to? For example is it run to age 105, 120. I am an FA and I get wholesalers pushing this strategy on me all the time and I just can’t get behind it for this reason. Most of the second to die life policies are Universal life policies which are just very long “term” policies that are designed to last longer than you do but if you live past the age they are run out to YOUR KIDS GET NOTHING. Ask whoever is reccomending this policy what age it is run out to and what happens if the last of you or your wife to die lives past that. You will be shocked at the answer.

Now they will tell you that you won’t live that long etc, but ask them why the insurance company caps it if that is the case. No one crunches numbers better than actuaries and they cap it for a reason. I guess my point is it is not risk free. My grandfather lived past 100 and died 15 years ago. What do you think they ran policies out to when people were buying them when he would have been age 60? 90, 95? Prolly not any longer than 100.

An easy way to see what age the policy that has been reccomended to you is run out to is to look at the illustration provided to you by the sales person. At some point usually 105 but no later than 120 the death benefit will be $0. 120 is the longest they are run out to but most are only run until 100 or 105 because it lowers the premium. It would be very unlikely one of you live past 120 but one of you could live past 100 or 105. Don’t buy this policy without being fully aware of this.

Also, have you considered spending down your tax deferred account first? Then the taxable account would transfer federal estate tax free (provided you do proper estate planning and have under 22.4 million to pass on) and with a step up in basis (meaning the cap gains will be tax free to kids). If avoiding estate taxes is your primary goal this may be a better route to go. Normally you spend the taxable first if you are worried about running out of money while alive but from your post that doesn’t seem to be a major concern for you.

Also the commission the sales person makes is usually 90% of the first years premium so they really want you to buy it. FYI
+1 - JMO, thanks for the "inside" view of these money traps. There is no free lunch, as you so aptly describe above.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

grandmacassie
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Re: Life Insurance policy to transfer wealth

Post by grandmacassie » Tue Jun 12, 2018 9:30 am

Couldn't you gift up to $15,000/year* to each of your kids without any tax consequence at all? This accomplishes two things: it puts $$ in your kids' pockets in the high expense years of growing families, and it allows you the flexibility to suspend the gifts at any time should market conditions and your need for income/capital warrant. You could do as we do and strongly suggest that these monies be invested for the long term. Why hand that kind of money over to an insurance company? By starting now the "kids" will have decades to invest and grow the funds. And the annual gifts have no tax consequences or even reporting requirements.

*I believe the amount was raised from $14k to $15k recently. Somebody correct me if I am wrong. The strategy still works, even so.

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David Jay
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Re: Life Insurance policy to transfer wealth

Post by David Jay » Tue Jun 12, 2018 9:57 am

grandmacassie wrote:
Tue Jun 12, 2018 9:30 am
Couldn't you gift up to $15,000/year* to each of your kids without any tax consequence at all?
And this is per person. So you and your spouse can give $15,000 each to each child and each spouse (if married), for a total of $60,000 a year to a married child+spouse.

And as G'ma Cassie points out, you are not locked into a contract if your financial situation (or economy) changes.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Reb Tevye
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Re: Life Insurance policy to transfer wealth

Post by Reb Tevye » Wed Jun 13, 2018 10:33 am

How about using your taxable account to pay the taxes on Roth conversions for a decade or so, and to make gifts to your children?
Roth and money they already have will be untaxed to them after your death. AFAIK.

I also don’t get the 5% return. Maybe 2% in a 30 year TMV calculation. Nominal 2%.
Either you are using 24k from your taxable account, and that would get a basis step up for them.
Or you are using 24k from your tax deferred accounts and you need to pay taxes yourself to get it. Right?
You said “transfer” 24k. Maybe I don’t know how this kind of life insurance premium can be paid.

I presume the insurance company also banks on some people missing a payment as they get old, and then losing 100% of the benefit and sunk premiums. That won’t happen to you or your 88-year old spouse, would it?

Don’t let the tax tail wag the dog, as they say.
"So, what would have been so terrible if I had a small fortune?"

suewolf
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Re: Life Insurance policy to transfer wealth

Post by suewolf » Wed Jun 13, 2018 10:43 am

thank you to all that have responded.
- to Grt2boutdoors: the return is "risk free" since it's guaranteed by the insurance contract (assuming insurance company is around).
If we die at age 93 and my sons are at the 35% tax bracket, I would need the equivalent to 5.2% interest rate to equal what they will receive tax free. I believe getting 5.2% over the next 30 years in the markets has some risk associated with it. (the interest rate is lower if my sons are at a lower tax rate)
- to Nate79: Good point that I should have been more clear on. My calculations show that even with RMD's, my tax deferred accounts will still be very large. And in terms of nominal terms....I'm comparing the value of what my sons would get when I'm age (say) 93. So I compare dollars they would receive from the insurance company in 33 years to the dollars they would get from my inheritance in the same year. So I think I'm comparing apples to apples - ie: same deflated dollars. Several of you have raised an excellent point however which is that the difference between a nominal return from my inheritance to the insurance company is smaller since the value will be deflated.
- to Letsgobobby: Yes my plan is to convert IRA's to Roths along the way. But I'm limited in this every year since I don't want to bump up into the next tax bracket. Still, I do need to do the calculation of how much I can really convert. Over 30 years, you'd think this would be substantial. Good point.
- to Jmo24: policy would run to age 120. I view it highly unlikely we'll live that long. You raise a good point with respect to the death benefit decreasing with advanced age. And I agree with you with spending down tax deferred as much as possible - good point in spending down first. Thanks so much for your perspective.
-David Jay:I certainly remember the high inflation times (our first mortgage was at 16% rates). I get you point - thanks. In the long term (30 Yrs), an average of 5.2 % return in real terms is what I would expect (2 points over inflation on average).
- to grandmacassie: Yes, gifting will figure in our plans. I just need to work it out between Roth conversion and any other options I have. Agree with you. And yes - we are not locked into a contract which is a good thing!

EXCELLENT advice thanks all. I will likely decline the insurance option.

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Reb Tevye
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Re: Life Insurance policy to transfer wealth

Post by Reb Tevye » Wed Jun 13, 2018 11:09 am

I can get the 5.2% with these inputs

PV = 0
FV = $1.6M ($1M / (1-35%-4%))
N = 30
PMT = $24k
payment at end of period

The error is that one must assume either paying premiums from taxable or tax deferred.
If from taxable, then the FV is $1M, assuming basis stepped up. Or $1M/0.96 accounting for estate tax.
If from tax deferred, then the PMT is not $24k, but $24k / (1 - OPTaxRate)
"So, what would have been so terrible if I had a small fortune?"

Grt2bOutdoors
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Re: Life Insurance policy to transfer wealth

Post by Grt2bOutdoors » Wed Jun 13, 2018 11:58 am

suewolf wrote:
Wed Jun 13, 2018 10:43 am
- to Grt2boutdoors: the return is "risk free" since it's guaranteed by the insurance contract (assuming insurance company is around).
EXCELLENT advice thanks all. I will likely decline the insurance option.
Something I learned long ago -there are only two things guaranteed in life - death and taxes. All else, requires much more than "if" a company, entity, person or building" is still around. Even "ironclad" trusts and contracts have been modified by the courts, years after the initiator had died, years after the trust being in existence. Nothing is guaranteed - countries which have gone through dictatorship know this all too well, the rule of law is not constant.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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