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Super-Roth-Likeness: Does it Walk Like a Duck?

Comedian Steven Wright tells of the time a burglar broke into his apartment while he was asleep, stole everything, and replaced it all with exact replicas. Later his best friend walked in, looked at Steve and said, “Do I know you?”

Americans have never been averse to imitations when the original was unavailable, especially when the substitute still did the job and was more economical as well.

This passion for the more commonplace might help you make sales to clients who have maxed out their qualified retirement options and are looking for an effective way to accumulate more for supplemental income when they no longer work. In this case there is an “imitation” that may be better than the original.
 
Consider a Roth IRA, best described as “a reverse traditional IRA.” Contributions are after-tax and distributions are tax-free. But consider, too, an over-funded universal life policy that builds significant cash value in later years.
 
Compare the features and uses of the two vehicles:
 
The perceived value of an executive bonus plan is greatly enhanced when the policy is designed as an over-funded contract and the possibility of withdrawals to supplement retirement income is highlighted at the time of implementation. But any client is more inclined to consider use of an insurance contract for retirement purposes when the similarities to a Roth IRA, or any qualified plan, are explained.
 
Speaking of similarities, there is the story of a citrus farmer in the Central Valley who has developed a grapefruit that looks exactly like an orange, except that it is bigger and it is yellow.
 
Get in touch to discuss how a client’s retirement can be better, or with any other planning questions that arise in your casework, at either 706.614.3796 or tom@cpsadvancedmarkets.com.
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The Problem With LTC Riders In The Third Person

Climatologists can argue all day about which hurricane was the worst. The fact of the matter is the “baddest” is the one that destroyed your home, the number of millibars notwithstanding. And back in the old days they all were the baddest because you didn’t have any warning.
 
Nowadays, sophisticated stuff starts measuring a storm as soon as some breeze off North Africa throws a few straws into the wind, allowing homeowners in the “cone” to take proper measures, and all the ships at sea.

And so it is with tax laws, the worst is the one that costs you – made worse by the fact that you didn’t see it coming.

And both may be true depending on how you structure third-person ownership of a life insurance policy with a chronic illness or LTC rider.
 
The most common planning question involves estate taxation.
 
Insureds want to keep the death benefits out of their taxable estate, but still want access to the rider benefits should the need arise. Policies with indemnity-type riders are commonly put in irrevocable trusts with the understanding that care costs can be paid out-of-pocket by the insured to reduce the taxable estate. If the cash payments under the rider are needed by the insured, the trust can provide for loans to the insured.
 
Reimbursement-type riders present a problem.
 
Because expenses are paid directly to the care provider the trustee is bound by the terms of the policy to benefit the creditors of the grantor/insured. This could constitute either an incident-of-ownership in the policy or a retained interest in the trust, either of which would have the effect of pulling death benefits back into the taxable estate.
 
But there may be another tax problem lurking in the weeds for trust-owned life policies, even those with indemnity-type riders, and this time it is an income tax issue. IRC 101 is the section allowing for income tax-free receipt of proceeds from a policy by reason of death.
 
Regarding treatment of accelerated death benefits subsection (g)(1)(B) says:
 
For purposes of this section, the following amounts shall be treated as an amount paid by reason of the death of an insured . . . Any amount received under a life insurance contract on the life of an insured who is a chronically ill individual.
 
But then the Code goes on to say in subsection (g)(3)(A):
 
In the case of an insured who is a chronically ill individual . . . [tax-free treatment as an accelerated death benefit] shall not apply to any payment received for any period unless— such payment is for costs incurred by the payee [the person getting paid the benefit, i.e. the policy owner] for qualified long-term care services provided for the insured for such period.
 
This raises the possibility that benefits paid to a third-party policyowner will not get income tax-free treatment under the rider because the third-party owner (the payee) did not incur the medical costs resulting in the claim. Material on the topic warns, “. . . there is no specific guidance from the Internal Revenue Service as to the tax effects of such third-party ownership . . . there is the risk that such ownership structure could cause adverse income, estate and/or gift tax consequences.”
 
The responsibility of the insurance advisor is clear.
 
When helping a client implement third-party ownership of a life policy with an LTC or chronic illness rider the client must be pressed to get the advice of a tax advisor.
 
To sow the wind by not doing so it to risk eventually reaping the whirlwind. For help in addressing this concern with you client, contact your LTC Sales & Marketing Manager.
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Who Qualifies For Non-Qualified?

In 1826 the German author Joseph Freiherr von Eichendorff (Jo-Eich for short) published a novella titled (in English) Memoirs of a Good-for-Nothing. Both he and it are unimportant except for a Latin phrase from the book: Quod licet Iovi, non licet bovi, translated, “What is permissible for Jove, is not permissible for the bull.” It describes the common double standard when, “what is permitted to one important person or group, is not permitted to everyone.”
 
Seems a bit unfair, but the expression can be turned on its head: “What is permissible to the bull, is not permissible to Jove.”

The visibility and responsibilities of those in high places often deny them the flexibility and lack of restraint enjoyed by the common folks in the seclusion and simplicity of their more private lives and smaller worlds.

A good example is in the matter of non-qualified benefits and owners of businesses; but the reversed double standard is caused by the tax law, not because of anyone’s high or low position or estate.
 
Consider the following assuming a 100% company owner with full-time employees.
 
Qualified Plans
 
These include benefits whose cost is immediately deductible to the employer, but for which taxation of those costs is deferred and not recognizable to the plan participants until benefits are actually received. The most common examples are qualified retirement plans. The limitations for the owner are, first, that there is a ceiling on how much can be contributed on his/her behalf. In addition, contributions must be made for qualifying employees, reducing the attractiveness of the plan for owner-retirement.
 
Non-Qualified Plans
 
These most commonly take the form of Deferred Compensation (DC) or Executive Bonus (EB) plans. Here the employer has broad latitude to discriminate regarding participation and the amount of benefits under the plan, but any employer deduction for a contribution must take place and only takes place when that amount is recognizable as income to the benefiting employee.
 
No Owner Advantage for a Pass-Through Entity
 
(An S-Corp, partnership, or an LLC taxed as either one) Premiums paid under an EB plan are deductible to the business, but recognizable on the owner’s W-2 that year. Any undistributed amounts held under a DC plan are still reported on the owner’s Schedule K-1 for that year.
 
No Advantage for C-Corp Owner
 
(Or an LLC taxed as a C-Corp) Here too, EB premiums are deductible to the company, but reportable on the owner’s W-2. But amounts held for a DC plan contribution fare even more poorly. The money held back is first taxed in the company’s corporate bracket. At distribution there is a business deduction, but the owner gets taxed again in his/her personal bracket.
 
Perhaps a More Advantageous Alternative
 
A personally-owned, over-funded life insurance policy acts much like a Roth IRA, but without all of the disadvantages of a Roth. Let’s talk about that next week.
 
Winston Churchill certainly understood the privileges of position. The story goes that one morning several subtle altercations had taken place between him and his long-standing personal valet, David Inches. Later in the day the following exchange took place: Churchill: You were very rude to me, Inches. Valet: You were very rude to me, sir. Churchill: Yes, but I’m a great man!
 
Get in touch to discuss how business owners can benefit themselves better or with any other planning questions that arise in your casework, at either 706-614-3796 or tom@cpsadvancedmarkets.com.
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Using Excess RMDs To Increase Your Legacy

The London Bach Choir has been around since 1876 when it debuted with a performance of Bach’s B Minor Mass. For the next ninety or so years their gig didn’t get much attention except among those with a musical preference for things like, well… the B Minor Mass.
 
But all that changed in 1969. Their exposure and listener-ship ballooned when popular singer-songwriter Michael Philip Jagger solicited their participation in a recording with his rock group, The Rolling Stones. The result was a tune that has since become a staple in The Stones’ performance repertoire and in the world of popular music.
 
Few today are unfamiliar with its iconic lyrics:
 
You can’t always get what you want. But if you try sometime, You just might find, You get what you need.
 
And so it is when older clients reach age 70-1/2 and want to use the required minimum distributions (RMDs) from qualified plans as a source of premium to buy insurance coverage, sometimes in response to carrier marketing programs encouraging the practice.

As an advisor, you should be aware of and alert your clients to several issues in this marketplace if you are to effectively manage expectations as well as make an achievable sale.

Middle-market prospects often don’t have financial justification for coverage.
 
In these days of sizeable lifetime exemptions most don’t face any anticipated estate tax and most don’t have an income replacement need because they have little or no earned income in their retirement years.
 
Carrier enthusiasm is curbed when traditional financial needs don’t exist.
 
And this despite marketing campaigns to the contrary. An underwriter on a case is like the conductor on a train. Nothing moves down the track till he or she gives the word. And sales pieces are not always run by a carrier’s “conductor” prior to distribution.
 
The percent-of-net-worth solution.
 
Many carriers are sympathetic to issuing insurance in an estate for liquidity, inheritance equalization, or the promotion of the ease of asset distribution. Consequently some will allow, even in the absence of traditional justification, an amount of coverage determined as a percent of the total estate, the number varying among receptive carriers. Existing coverage is taken into account.
 
So don’t just throw an app up against the wall.
 
You must know the sympathetic carriers and be able to state a purpose for coverage other than “to increase the legacy.” Those words were used in the title only to get your attention. If you use them on an app they will surely get the attention of an underwriter, but not with beneficial results.
 
Give us your client’s situation and let us informally financially shop your case. When submitted the stated purpose will be “see attached cover letter” which we will write for you based on prior conversations with the underwriter.
 
It is worth the time. The coverage is on an older client utilizing a permanent product, a sale that will result justifiable compensation for your extra effort.
 
Both The Rolling Stones and the Bach Choir are still with us. Jumpin’ Jack isn’t as Flashy as he once was. But the Choir rolls on even expanding its footprint in the world of popular entertainment, participating in the soundtrack of movies like Robin Hood, The Chronicles of Narnia, Shrek the Third and Jack the Giant Slayer.
 
Call us with any older-client case you have at 706-614-3796 or tom@cpsadvancedmarkets.com. You just might find that what you need is what you want.
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Unlock More Key-Person Coverage

Real old-timers remember the days of one of comedy’s iconic duos, the husband and wife team of George Burns and Gracie Allen. Any younger connoisseurs of good humor would do well to spend some online-time calling up at least some of their radio, television, and cinema work-product on YouTube or some other source. But search engines didn’t help me uncover one famous routine, so I will paraphrase:
 
Gracie: Did you hear that my friend got hit by a car that didn’t have its headlights on? George: That’s awful! Why didn’t the driver bother to use the headlights? Gracie: Because it wasn’t dark yet!

Knowing all the facts can certainly change the response to circumstances.

And so it is when talking to a business owner about how much company-owned coverage he or she can get on an important executive. Consider:
 
The standard key-person formula.
 
Most carriers will allow a business to own coverage on an important executive in the amount of ten times his or her compensation package. This includes not just W-2 salary, but also bonuses, cost of perks (e.g. club memberships), fringe benefit costs (e.g. health insurance, etc.), qualified retirement plan contributions, deferred compensation, as well as the use of a company car or other business assets.
 
Stretching the limits a bit.
 
Some carriers will allow a larger multiple for financial justification. But some might impose a lower multiple as well if it appears unlikely the executive will work for ten more years. When owner-executives are involved a carrier may allow for part of the proposed insured’s Schedule K income to be taken into consideration. If the proposed insured is being awarded ownership interests, the value of those interests might be treated as compensation.
 
Debt can help.
 
Some carriers will allow additional coverage based on a percentage of the company’s longer-term obligations to financial institutions if it can be shown that loss of the executive will curtail the company’s ability to repay. Sometimes the policy is initiated by a lender’s requirement, in which case the financial institution is secured through a collateral assignment.
 
Redemption obligations.
 
A major reason a business may be economically burdened by the death of an executive is the existence of an agreement to buy his or her ownership interest in the company from the surviving family. The agreed purchase price can be added to the amount of coverage sought. If no agreement exists this might open up a discussion of that planning need with the client.
 
Company-owned policies are often more easily placed because the limited time for which coverage is needed (till the insured’s anticipated retirement or for the expected period of service) make economical term insurance a good product choice.
 
Call with questions on or assistance with your next key person or other personal or business planning case at 706-614-3796 or tom@cpsadvancedmarkets.com.
 
George Burns lost his show-biz and life partner in 1964. His career continued after Gracie until he passed away 32 years later, just 49 days after his 100th birthday. So we will end with the signature closing of Burns & Allen:
 
George: Say good-night, Gracie. Gracie: Good-night, Gracie!
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162 Executive Bonus – Making It “Seem Kinda Tax-Free” Up Front

When discussing and designing executive bonus plans, too much time is lost talking about and describing “single bonus” and “double bonus” methods, and too many cases may be lost because they haven’t been discussed at all.
 
Just a quick study of vanilla executive bonus:
 
The employer (ER) agrees to pay the cost of a selected employee’s (EE’s) life insurance plan (or any other asset for that matter – but that’s another topic). The ER gets to deduct the amount paid to the carrier and then reports it on the EE’s W-2. Boom! At the end of the year the EE realizes an increase in his or her tax bill for what has been, in effect, a non-cash benefit.

Even with proper forewarning, the effect under the “single bonus” method can result in the plan losing its luster in the eyes of the participant when tax time rolls around.

So, then you explain that the ER can avoid this delayed sticker shock by “grossing up” the bonus so that the amount committed to the plan each year equals the anticipated cost of coverage, and the tax that will be due on the total “double bonus.” But if the double bonus method is explained to the ER in response to this concern, it can leave him or her feeling that he or she must commit more than anticipated in order for the plan to keep its sizzle.
 
The psychologically sound sales solution:
 
Don’t mention double or single bonus at all. Once you have determined that an ER wants to assist an EE with the cost of insurance, focus on the amount they are willing to commit. Then, back into the coverage that can be purchased with what would be the after-tax portion. Once the breakdown is established and the plan is in place, it is easy for the ER to send the premium amount to the carrier and withhold the remainder.
 
The ER is still within the original budget, and the benefit is presented to the EE with the assurance that there will be no out-of-pocket tax due at the end of the year as a result of the coverage. The transaction is not a non-recognizable event to the EE, but when explained and implemented correctly, it will have that sensation on April 15.
 
Don’t forget the participation possibilities:
 
If the after-tax amount of the bonus is less than what the participant to the plan might need to achieve an overall risk management goal, emphasize that the policy belongs to the EE and it can be designed so that it provides the total coverage needed with the commitment of additional personal premium payments, either through payroll deduction, if the ER agrees, or by direct payment.
 
A properly designed executive bonus plan doesn’t solve every non-qualified benefit need, but almost. Call for assistance on any case design work you have.
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Idioms & Grantor Trusts: Having It Both Ways (For Now)

You can’t eat your cake and have it, too!
 
We’ve all said it many times and in every case we were talking about more than just desserts. Layered within the phrase is the more subtle and intended message that you can’t have it both ways; or that to get something you’ve got to give up something else.
 
Our conversations are peppered with idioms, those oft-used little word-packages whose literal meaning have nothing to do with what they actually communicate. For the outsider struggling to learn the language, idioms can cause more roadblocks to understanding that all the other irregularities of grammar and spelling that attend the King’s English. And it gets more confusing when an idiomatic truth proves unreliable; as in the case of grantor trusts.

These grantor/intentionally-defective/irrevocable/lay in the house that Jack built/life insurance trusts turn the idiom on its head by allowing, from at least a tax perspective, a taxpayer to have it both ways.

Consider the advantages a grantor trust can provide if all is properly done:
 
  • For estate tax purposes: All property in the trust is not included in the trust-maker’s taxable estate, offering significant tax savings on both the original principal and on appreciation after transfer to the trust.
  • For income tax purposes: The consequences of all that takes place in the trust flow back to the personal return of the trust-maker. This a) allows more control over the severity of the tax – especially if the maker has certain tax advantages in play, and b) avoids depletion of assets in the trust to make tax payments and, by paying the trust’s tax, allows for a gift tax-free benefit to the trust by the maker.
Let’s keep the ball rolling. While the maker is enjoying the best of both tax worlds, he or she also benefits in that:
  • Assets in the trust are protected from the claims of the maker’s creditors.
  • If the maker is married, he or she can maintain remarkable degrees of vicarious control over and access to property in the trust by establishing a life estate in the spouse.
If you want to hide a barn you shouldn’t paint it red. It’s no surprise that a planning device with this many advantages has caught the attention of the lawmakers.
 
If lack of familiarity with common idioms is hampering you then it’s time you pulled yourself up by your own bootstraps, put your nose to the grindstone, and began to get the lay of the land on such things. Or simply contact me with questions that come up in your casework concerning grantor trusts, at 706-614-3796 or tom@cpsadvancedmarkets.com. When we are done you will know your noodles.
 
By the way, my Mother never quite got the hang of making cakes from scratch. Her marble cakes were always so hard we just took them for granite.
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Is Insurance In A Qualified Plan Beneficial?

Whenever life insurance is proposed the first two client-questions that inevitably follow are: first, how much will it cost and then, are the premiums deductible (especially if the client is a business-person). Let’s deal with the second.
 
In a business situation life insurance premiums are never deductible. Even in an executive bonus arrangement the employer can write off amounts paid only because, in fact, the amounts are W-2 compensation, not because they are eventually spent on life insurance.

In the personal context there hovers about the discussion of tax-deductible costs for coverage the possibility of holding life insurance in a qualified plan.

It sounds good at first blush. Contribute to the plan and use the untaxed dollars to buy a policy. But take a closer look.
 
Permanent insurance outside a plan can be broken down into three parts.
 
On the bottom is basis, the after-tax dollars used to pay premiums (it can be a little more complicated than that, but let’s keep in simple). Above that is the potentially taxable, but currently tax-deferred gain in the policy, i.e. the reserves in excess of the basis. On top is the risk portion, the amount of death benefit over the policy values.
 
Two tax advantages to keep in mind with non-plan coverage are:
  • So long as the policy stays in force prior to death, the gain in the policy can be protected from taxation
  • In the event of death the whole kit and caboodle (basis, gain and risk) is paid to the beneficiary income tax-free
Now compare to the taxation of a policy in a qualified plan.
 
Untaxed dollars inside the plan are used to buy the life insurance. So far so good. But next the plan administrator must report each year as taxable income to the insured plan participant the “economic benefit” realized by the coverage. This is often calculated using the carrier’s one-year term rates acceptable to the IRS.
 
The result is an amount usually lower than the actual premiums paid. On balance the participant comes out ahead, but not with as much sizzle as they may have anticipated.
 
What will follow from there is one of two unavoidable tax disadvantages that are avoided with insurance outside the plan.
 
If the participant retires or otherwise separates from service most plans do not allow the policy to remain in the plan. If the policy is distributed its FMV (usually the account value) must be recognized to the extent of the FMV exceeds the accumulated economic benefits recognized over the years of participation, i.e. the gain is taxed, a result that would not have happened with coverage outside the plan. The participant can buy the policy out of the plan, but the result is the same. The heretofore untaxed gain in the contract is not purchased with after-tax dollars.
 
If the participant dies while the policy is in the plan the beneficiary receives the death benefit tax-free only to the extent that it exceeds the policy value minus the accumulated economic benefits. Again, the gain in the policy is taxed, unlike when a death benefit is received for coverage outside the plan.
 
There will always be taxation of the policy gain. In addition, if the insured anticipates death tax liability, either federal or state or both, the proceeds from a plan-owned policy cannot be kept out of the taxable estate. Both are things to consider before hastily buying coverage inside a qualified plan with the hope of, at least, part of its cost being paid for with untaxed dollars.
 
Call with any question concerning coverage inside or outside a plan.
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Uncovering Sales Opportunities And Limiting Liability Exposures Through Trust Owned Policy Reviews

While many advisors implement conservative, guaranteed solutions in trust owned policy arrangements, this is not a universal practice.
 
In a low interest rate environment, many policies that are held in trust may be under-performing and do not have the underlying guarantees to ensure that the policy does not lapse prematurely and that the primary objectives for the insurance planning are obtained.
 
Consider This Scenario
 
In a recent conversation with a carrier representative, they shared an instance in which the trust beneficiaries brought a law suit upon the writing agent, the broker general agent and also the carrier for failing to implement a sound insurance strategy and perform periodic reviews to avoid a premature lapse.
 
Fortunately, there had been a policy review conducted within the last 36 months in which the under-performance was identified and an alternative solution was recommended.
 
The insured (parents of the trust beneficiaries) elected not to pursue this recommendation and failed to inform their children that the review had taken place. The courts held that this effort was enough to avoid adverse litigation and the case was dismissed.
 
Penetrate A New Market
 
This story can be a great conversation starter with any CPA’s, Estate Planning Attorney’s or Trust Companies. You may even know a friend or family member who is serving as a trustee who could be exposed to this potential liability.
 
By offering a complimentary policy review of any trust held policies, you can strengthen your relationships with these professionals – which can lead to future referral opportunities.
 
There may even be a more cost effective policy solution available even if the current plan is not under-performing.
 
We can help streamline the policy review process and for more complex trust planning designs; we can leverage our Director of Advanced Markets, Tom Virkler, JD.
 
Given that most policies held in trust are larger face amounts on older individuals, doing one of these reviews each month could result in a sizable increase in your income.
 
For assistance with a policy review, please contact your Life Sales Rep.
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Properly Documenting Your Clients Intentions

In the most important episode of his life Paul Revere did not fire a shot. But his willingness to spread the alarm averted what could have been an early military disaster for the revolutionists of Massachusetts Bay.
 
Planners, too, in addition to fulfillment of their usual responsibilities must fill the role of an alarmist if they are to keep their clientele financially whole.

The sad truth is that if your clients do not take the time to plan correctly the government is poised to do it for them poorly when the need arises.

State laws allows for a citizens to assure that their affairs are handled according to their wishes, but they must takes steps to document their intentions properly.
 
Proper documentation can be achieved through the execution of these three basic planning documents:
  • A durable Power of Attorney that permits an appointed agent (attorney-in-fact) to conduct financial transactions for your client under the terms expressed.
  • A Health Care Directive (a/k/a – healthcare proxy, living will, durable power of attorney for health care) that appoints an agent to make health care decisions if the client becomes unable to do so.
  • A Last Will & Testament that, upon death, allows the client to a) decide who will receive the assets owned by the client, b) appoint who will manage those assets, c) state preferences for the guardian of the client’s minor children, and d) appoint trustees of trusts created by the Will.
If these are not in place a client must understand that there is legislation in every state that will make these decisions for them.
 
Broaden the influence you have with and the comprehensiveness of the service you provide to your clients by asking them if they have taken the time have drafted at least the three fundamental planning documents listed above.
 
We do not practice law or offer legal advice (nor do you), but will look at a client’s planning documents to direct them better when they have them reviewed by legal counsel. Give us a call.

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