The term “High Net Worth” (HNW) might evoke different images to different people. To the average American, “high net worth” might constitute as an individual who has a couple million of dollars sitting in the bank. To wealthier individuals, the phrase might only apply to individuals in the upper 1% of the population, or those with tens of millions worth of assets.
When it comes to utilizing life insurance as a tool to generate more wealth and ensure one’s legacy, the reality of estate planning as it applies to high net worth individuals becomes highly complex as the more wealth that the individual possesses and continues to accumulate, the more complex the estate plan becomes and the more that will be owed to the government.
This article explores solutions in bridging the gap between preserving an individual’s wealth and using creative, efficient and comprehensive solutions for the high net worth individual to visualize strategies that will ensure their financial success for not only themselves but for their heirs as well.
While estate planning is a very important tool for every household and not just for the HNW individual, the reality is that for this niche population, the risk that HNW families face from a tax perspective are exponentially greater.
Life Insurance: Key Strategies for High Net Worth Individuals
Life insurance is an essential part of any comprehensive estate plan, providing tremendous financial and tax benefits to the estate and heirs.
1. Two major potential benefits of utilizing life insurance are to ensure liquidity and financial leverage. This is due to the fact that the actual cash value of the policy can be accessed easily. A high cash value policy can secure the safety and liquidity of your money while maximizing your growth rate. Early high cash value and long-term performance are highly achievable when you design the policy in a customized design. This custom design includes specific funding ratios and high-performance custom modifications to a index universal policy. While not everyone uses them, it allows for a liquidity of $0.85 cents to $0.92 cents on the dollar on the policy day one and 100 cents on a dollar within 3 years. In addition, death benefits are available to the beneficiary or trustee promptly, ensuring that neither has to sell off any assets. Taxes must be planned for, especially in situations where the value exceeds the permitted exemption amounts. Furthermore, these taxes must be paid within nine months of the estate holder’s death. Selling off assets at the highest price may not coincide with the IRS time frame for tax payment purposes.
2. Using Life Insurance to pay your estate tax: In 2020 the tax code provides that every penny in excess of $11.58 million dollars per individual ($23.16 per married couple) is taxed upon death at rates that rapidly escalate to 40%. Beginning on January 1, 2026, the exemptions revert to the $5 million exemption level (indexed for inflation). There is a possibility based on election results that exclusion allowance will be even further reduced and tax rates increased.
It is vital for a HNW individual to make sure that their estate possesses enough liquidity to address the costs that will arise as their estate is settled, which can include paying debts, buying out the business, but most frequently, federal estate taxes. In HNW situations where the value exceeds the permitted exemption amounts, these taxes must be planned for. Being taxed at 40% is no laughing matter, especially if your estate is in the double or triple million digits. To make matters worse, there also may be state income taxes due as well, depending on the state of residence.
3. Life Insurance to fund the continuation of your business: HNW individuals have the ability to ensure that the continuity of their business will be closely held by their family members by converting life insurance into enough liquidity to enable the family members to control or purchase the company. In some or most cases, a buy-sell or key-man policy agreement can be funded by the insurance policy and can readily be utilized for this purpose. In other cases, death benefit proceeds can be converted into quick cash, allowing family members the chance to maintain a stake or majority in the business, or for the business to continue operations without financial disturbance.
4. Irrevocable Life Insurance Trusts: An ILIT (irrevocable life insurance trust) is used as a special trust which serves as both the owner and beneficiary of one or more life insurance policies. It serves as an estate planning tool that is used to protect assets from being subject to estate taxes. When the funds are transferred into an ILIT, that trust, in turn, can be used to purchase or pay the insurance premiums. ILITS have become extremely popular among HNW households and can provide the estate with much needed liquidity and flexibility, ensuring the ultimate security of the HNW’s legacy.
5. Utilizing the Premium financing option, While the concept of using life insurance for estate planning has been around for decades, the challenge has always been paying the premium. For the ultra-wealthy clients, where the face amount on the policy is large enough to meet the projected need, the correlating premium is also high. This high premium amount either exceeded annual gifting limits, exceeded current cash flow or both. Thus, we saw the development of Premium Financing as a way to bridge the gap and solve these significant problems. This is the structure of choiceamong the affluent. This allows the client to keep their money working at the most effective rate, usually either in their business or personal portfolio. In discussing a client’s ROI (rate of return) versus cost of borrowing, here is an example: There is an 8.5% cap rate on a real estate portfolio, versus the cost of borrowing at 2.75%. This creates a positive arbitrage of 5.75 return.
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