Saturday, July 17, 2004

Paid-up policy is 'lazy dollars'

By J. Brendan Ryan
Enquirer contributor

Question: I am a 78-year-old male nonsmoker in reasonably good health. I have a special kind of whole life that has a death benefit of $500,000 and current cash value of $400,000. I have a loan of $125,000 at 6 percent against the cash value. The policy is paid up, and I let the annual interest increase the loan each year. My estate will probably be subject to estate tax. Is there away to improve my situation without my having to pay any more out-of-pocket?

Answer: The policy has a sufficient amount of remaining cash value to last without further premium or interest payments. But, because you own the policy, the death benefit will be counted in your estate for estate-tax purposes, assuming that your estate will be subject to such tax. Depending upon the tax law at the time, the benefit may be reduced by perhaps 45 percent.

Given that there is a pure death benefit (amount of insurance minus cash value) of just $100,000, it's clear that your cash value of $400,000 is not working as hard for you as it could. These are "lazy dollars."

If you think your policy will be taxed in your estate, in order to avoid that estate taxation you could make a gift of the policy to an irrevocable trust. As long as you survive at least three years after the gift, the insurance would not be counted in your estate for tax purposes. A gift of that size, of course, would have gift-tax implications, which are beyond the scope of this discussion.

But such a gift means that you lose control and use of your property. When you establish an irrevocable trust, you give the trustee authority to use the assets in certain ways and to ultimately distribute them to the beneficiaries whom you have specified. But you cannot personally benefit from the trust assets or influence the trustee in the administration of the trust.

You have indicated that this is not acceptable, that you are not willing to give up ownership of such a large amount of money.

You can address both the tax problem and the "lazy dollar" problem simultaneously. I suggest that you borrow $7,000 per year from your present policy. You should give that annual amount to an irrevocable trust. With your cooperation the trustee would own a $175,000 policy on your life. The $7,000 annual gift, which would not incur any gift tax, would pay for the policy. Your present policy is projected to remain in safe water even with the $7,000 annual withdrawal.

In this way, you reduce your cash value by less than 2 percent per year and increase the death benefit by a tax-free 35 percent.

Such a technique could allow continuing to own the present policy but to use a small part of it each year to fund a new life-insurance policy that would be owned by an irrevocable trust and thus not taxed in your estate. In this way you can increase the overall amount of your life insurance designated for your heirs, gradually decrease the amount of your estate potentially subject to estate taxation, and give up little control in the process while spending no more money out-of-pocket.

All of the above numbers assume that you are able to qualify for the new coverage at favorable rates and that interest and mortality assumptions remain the same. In reality, commentators are confident that both interest and mortality will improve in the future. Any such improvement would improve the above numbers.

J. Brendan Ryan is a Cincinnati insurance agent. His column appears every other Saturday. Contact him at 2212 Victory Parkway, Cincinnati 45206; 221-1454; fax 221-3447; or e-mail

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