We all know people who are "house-poor". They've tied up more than they should in their home and lifestyles and simply can't meet their reasonable financial goals.
Others are "insurance-poor". They may have retired. They may have sold their businesses. Their children may have grown up or they may have taken steps to shrink their eventual estates. But they feel committed to continue paying premiums on life insurance which has outlived its usefulness.
Yet, the owners of insurance policies whose missions have been aborted may think they have no real choice but to spend good money after bad. After all, they don't want to surrender a policy merely for its cash value and give up any right to the death benefits for which they've paid all those years.
An owner of such insurance might try to re-engineer its purpose. For instance, she may want to deposit her policy into an irrevocable trust, where the proceeds can fund estate taxes without themselves ratcheting up the size of her taxable estate. But, if she doesn't live for three years after the transfer, the policy proceeds will be estate-taxed and the strategy will be defeated.
What's the solution?
A growing number of financial companies are buying up policies issued by virtually any insurer. So, an owner of a life insurance policy can now sell it for a percentage of its net face value and not just its cash value. This new opportunity results from an expansion of the "viatical settlement"-the sale of a life insurance policy at a discount from its face value, usually by a terminally ill policyholder who needs cash for medical or living expenses. But illness is no longer a requirement of cashing out for more than cash value.
The money one receives from a policy sale can be used for any purpose, including funding an irrevocable insurance trust. And, if one sells a policy and gives the cash received to a trust which then buys a new policy, the policy proceeds won't be estate-taxable no matter when the insured dies.
Not only can liquidity be freed up from a policy which isn't worth its salt anymore, but a friendly income tax result is available, too. When a policy is sold, only the amount by which its surrender value exceeds its tax basis will be taxed at ordinary income-tax rates. All the sale proceeds in excess of surrender value and tax basis are taxed at favorable, long-term capital gain rates.
The after-tax proceeds can do all kinds of good things. They might be added to one's investment portfolio. They might fund long-term care insurance, a charitable trust or a Medicaid annuity. Or, they might buy stock from a fellow stockholder in a closely-held corporation. The choice becomes the policyholder's, whose targeted objectives may now be achieved without tapping other resources.
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.