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The Policy Review and Pandora’s Box

[ 0 ] April 30, 2014

Spectrum Financial Solutions, FL, Life insuranceIt all started as a simple question during a round of golf with friends.  I don’t discuss business on the golf course ordinarily… it gets in the way of the jokes, jibes, witnessing good and bad play and my near manic pursuit of par.

On this day, my playing partner asked me a question about his and his wife’s life insurance policies with a major mutual life insurance company (policies I didn’t place for my friends).  I said that I couldn’t answer his question adequately at that time but would be happy to meet with him at a later date.  Because of scheduling issues, we met several months later.

In advance of the meeting, I requested a great deal of material:  pre-sale illustrations, copies of policies, annual statements, trust agreements, if any, and any communication regarding original concept backing up the policies.  This information was critical to the face-to-face with my friend and his wife.

The dialogue at our meeting indicated that the policies were purchased in order to provide interim death benefits for income replacement but more importantly, the substantially overfunded policies were meant to provide tax advantaged post-retirement benefits many years down the road.  The policies on my friend and his wife were owned by irrevocable life insurance trusts, which raised a question in my mind as to proper ownership.

It should be noted that this couple are Non-Resident Aliens (NRA) but intend to gain US citizenship, when possible, in several years time.  It was stated that the trusts were designed to mitigate any estate tax issues that an NRA might experience from ownership of a U.S. life insurance policy at his or her death.

The policies (one on each of couple), when issued, were designed to become Modified Endowment Contracts (MEC), which runs counter to the goal of creating the most efficient post-retirement, tax advantaged income stream for the couple.  Under the current policies, should the client choose to receive payments (if even possible under the trust agreement), they would be taxable as ordinary income until such time as all accumulation in excess of cost basis is consumed.  Add to that the potential for a 10% penalty for distributions prior to age 59½… serious structural issues emerge and the hinges of a Pandora’s Box started to loosen.

Whereas the policy review was intended to determine whether the life insurance policies were the best means of providing for the clients’ long term goals, it uncovered a number of issues that, left unattended to, would impact, if not undermine their primary goals and planning.

Many questions emerged… Were irrevocable life insurance trusts appropriate in light of the stated goal of providing living benefits for my clients?  Were Crummey Letters sent out to beneficiaries as mandated in the trust document?  Did the Trust document(s) apply for and receive Federal Tax ID numbers?  Was the wife’s trust actually signed and witnessed?  The answers were all no or maybe, at best.

As to the life policies that were the focus of my review, they were rather uncomplicated and straight forward.  The current policies were compared to alternatives and shown to be less advantageous than new policy designs.  And correction the MEC issues only complimented the situation.

This note wasn’t meant to be a case study… I could go on for many pages commenting on various aspects of the program.  Rather, it only serves to illustrate that a second or third set of eyes reviewing older life insurance programs, revisiting goals and objectives and the documents supporting them is a prudent exercise that makes a great deal of sense.

What would have been a much larger issue as time went on is being addressed currently. And, Pandora’s Box never opened.

Written by Nunya Bidness.

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