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One of the many impacts COVID-19 has had on us is a sharp awakening to the need to create a plan for what will happen in the event of one’s death. We’ve heard from many advisors with clients who are working on their wills and are reaching out to discuss securing life insurance protection, and their legacies. For the right client, life insurance can be an efficient way to pass money from one generation to the next.

It all starts with the client conversation. The process should be built around making sure for the client that the right people get the right things in the right way. The conversation may include, in addition to Saybrus and the client’s financial advisor, select family members, attorneys and tax professionals.

For a lot of clients — and these are clients generally between the ages of 65 and 80 who are already retired — a big part of that discussion is understanding what their goals are and their overall financial picture. The discussion should also seek to identify assets that aren’t needed specifically for retirement and could be legacy assets. There are four common places advisors can find assets that might not be needed and can be earmarked for an inheritance.

Legacy assets may be found as annuities that were originally bought for retirement purposes but once the client is in retirement, are not needed for income. IRAs are another common place where we can find legacy money that won’t be used for retirement. Other typical sources include general non-qualified investment accounts and Roth IRAs.

There are advantages and disadvantages to using those assets both in retirement planning and for wealth transfer purposes. For example, when an annuity is passed to a beneficiary, the gains inside the annuity can be taxed as ordinary income.

An IRA has, just like an annuity, tax-deferred growth throughout earning years and retirement years until you begin taking distributions from the IRA. But, upon inheritance, that IRA is going to be taxable to the heirs, who in many cases may be in their peak earning years and subject to a higher tax bracket.

With non-qualified accounts like a brokerage account, taxes are paid as gains are realized. Ultimately, when the asset is inherited there is a step-up in basis.

A Roth IRA is an excellent place for a client to have money when they pass away. That said, a Roth IRA is still a relatively new financial instrument, so many clients haven’t had the length of time in the work force with a Roth IRA available to build up a large balance, or they may be hesitant to do a Roth conversion with existing assets because of the potential tax hit.

While no one vehicle is the answer for legacy planning, life insurance can be an additional piece of the puzzle to help make wealth transfer more efficient.

The number one benefit to using life insurance as a wealth transfer vehicle is that it can provide a predictable death benefit for the beneficiary, even in a market downturn.

If a client has a $500,000 life insurance death benefit and we come to a dramatic sustained drop in the market, the client’s other assets may be impacted, but if structured in the right way, a life insurance death benefit will remain fixed at $500,000.

Tax benefits associated with life insurance are another win for beneficiaries. As a general rule, a life insurance death benefit will pass to heirs 100% income tax free. That could become even more appealing if tax rates rise in the future.

A third benefit is that the rate of return compared to premiums paid can be very competitive. The rate of return on the death benefit will depend upon when the client ultimately passes away, but as an example, at life expectancy a rate of return for the life insurance can be somewhere in the neighborhood of 6% to 8%.

Clients also have complete control over beneficiaries listed for life insurance and it’s easy for them to change beneficiaries, if necessary.

Lastly, the death benefit itself is 100% liquid. If a client has assets like a vacation home or a business, they may need to be sold to properly distribute the value of the assets among heirs. Life insurance, because it’s 100% liquid, can be an effective way to facilitate a buyout.

When considering life insurance for wealth transfer, there are three things that have to be present for it to be appropriate for a certain client.

First, of course, is the client’s desire to leave legacy assets to an heir. “The client has to want to leave more, to proactively plan their legacy for their family or a church or charity. Most clients do have that desire as long as it won’t affect their retirement lifestyle.

Obviously if a client doesn’t have legacy assets that aren’t needed for retirement, they can’t pass them on to their heirs, so an advisor has to take a close look at their client’s full financial picture. Clients should have a stable retirement picture in terms of income and a plan for funding for long term care needs. The clients must also be healthy enough to qualify for the life insurance. Most insurers will underwrite a client up to age 90, but it’s better to start when the client is between 65 and 80.

Establishing a legacy plan may be easy for clients to put off, but time is of the essence. With markets at all-time highs, now is a great time to reposition some of the market gains over the last couple of years into a legacy plan.

It has been estimated that up to $68 trillion will move between generations in the next 25 years. This presents an opportunity for advisors to assist their older clients in ensuring a smooth transition of assets to the people and causes for which they care most. We sat down with Saybrus Partners National Sales Director Palmer Williams to talk further about the trends and considerations for wealth transfer today.

What economic, demographic and market trends are shaping wealth transfer policies today?

There is an unprecedented time now for wealth transfer planning due to a variety of factors. First and foremost, we are arguably in the friendliest federal estate tax environment ever. Under current law in 2020, individuals can pass on up to $11.58 million estate tax free to their heirs. Married couples can leave double that amount – $23.16 million. As a result, clients who have previously been hesitant to use life insurance for wealth transfer because it involved creating trusts and relinquishing access to their money now can enjoy all the benefits of life insurance and maintain control of the policy.

Another trend that is creating new wealth transfer opportunities today is favorable market returns. With the stock market achieving unprecedented growth over the last 10 years, many clients are now well positioned to leave a legacy to their family or favorite cause. At the same time, they are also understandably concerned that their gains could be erased by the next inevitable market correction, and leave a diminished estate for their heirs. Life insurance is an appealing solution for this problem. A client can reposition earnings and gain leverage with a non-correlated asset that is earmarked for their heirs. This way, the increased life insurance benefit can serve as a hedge against market volatility and secure the legacy the client wants to pass on.

Looking at wealth transfer from a demographic standpoint, with the Baby Boomers aging, more clients than ever are in their retirement years. We see most often that a primary goal of these clients after providing a secure and comfortable retirement lifestyle is wealth transfer. They recognize that many of the financial opportunities available to them, such as affordable education, employer-provided pensions and social security, may not be available for younger generations. These clients often want to provide enough assistance for their loved ones to live full and comfortable lives. At the same time, many families’ inheritance disappears once it is transferred to the second and to the third generation. The good news is that life insurance in concert with a properly designed trust can be powerful wealth transfer tools to help clients’ ensure their legacy while controlling the amount and timeframe in which beneficiaries receive their inheritance.

How are wealth transfer policies being used by consumers in light of these trends?

 First and foremost, appropriate candidates for wealth transfer policies are 65 to 80-years old, and are comfortably secure in their retirement. These consumers want to leave a legacy and we often recommend using life insurance, because it offers a liquid, predictable and defined death benefit. Additionally, the internal rate of return on the death benefit at life expectancy is generally between 6 and 7.5 percent, and the proceeds from life insurance generally pass to heirs income tax-free. Especially for Baby Boomers and older retirees whose risk tolerance is lower, life insurance offers a competitive rate of return on their premiums.

Clients are also utilizing the many features of life insurance that are useful during one’s lifetime. Life insurance cash values grow on a tax-deferred basis, and can be accessed through loans and withdrawals, allowing clients to put wealth transfer plans in place while maintaining financial flexibility for the future. If the client’s needs change, the cash value can be a source of funds to reduce premiums,  adjust coverage or simply help pay for college tuition, a wedding or emergencies. Living benefit riders are also frequently included or purchased with policies to help prepare for potential long term care needs.

What key things should consumers consider when they are thinking of using life insurance for wealth transfer?

 Clients must first have a desire to leave a legacy to loved ones, a charitable organization, or educational institution.  They should have liquid assets that are not earmarked or needed for their retirement income or potential risks such as a major health crisis. To put it into numbers, a good guideline for this strategy is to consider it for clients with $500K+ in investable assets.

The other key consideration is that clients need to be healthy enough to qualify for the life insurance at premium rates that make sense. If they are reasonably healthy with no serious chronic health conditions or risk factors, the policy should offer affordable premiums and the leverage that help make life insurance an attractive wealth transfer strategy.

Lastly, it is crucial to plan 10 to 15-years down the road and design a flexible plan, as a client’s financial situation and goals will surely change. Advisors should ensure that clients have options should they need to modify or exit a policy.

How should a financial advisor recommend wealth transfer as part of the retirement planning process to his prospects and clients?

Advisors should first take the time to learn about a client’s life, family and interests. A client’s legacy is a very personal thing, and the Advisor should ensure the proposed strategy reflects the client’s values and goals.

Second, Advisors should consider specific policy options their client will need for their individual situation. For example, if a married couple does not need the life insurance individually, but purely as a vehicle to transfer wealth to heirs, a survivorship policy that pays the benefit upon the second death of the couple would be an appropriate choice. Purchasing a survivorship policy rather than two individual policies will further increase leverage versus premium paid. Other policy features to consider are important riders such as chronic illness or long term care, which is often critical as clients advance in age.

Finally, when selecting a policy, advisors should make sure it offers the flexibility of a cash value design, so the policyholder can access the premiums accrued should a financial or health crisis arise later in life. With this type of policy, clients may have the flexibility to 1) unwind premiums they have already paid into the policy, 2) use the cash value to pay premium rather than pay out of pocket or 3) reduce the death benefit so they have lower premiums to pay.

What are biggest wealth transfer trends you are seeing in 2020?

With the upcoming election, we’re keeping an eye out for what could happen to estate tax laws, as this will directly affect wealth transfer. Estate tax laws seem to ebb and flow in terms of thresholds and rates, and they will likely continue to change in the future. This will be especially important to pay attention to for clients with assets totaling $1 million and above.

On the product front, we expect to see continued innovations with more survivorship policy options and more cash value products. Living benefits are becoming much more prevalent, increasing competition among carriers. Here we expect to see an expansion in the qualifying events that will trigger the claims process as well as entirely new features associated with these LTC and chronic illness riders.  In the past, life insurance policies have been a great value proposition for the beneficiaries, and these enhancements bring significant value for the insured as well.