Financial Statement-Based Planning Opportunities
Financial Statement-Based Planning Opportunities

Have any of your clients completed a personal financial statement within the past several years? If so, a simple review of the assets and sources of income listed on the financial statement may reveal some planning opportunities to help your clients more effectively transfer wealth to their heirs.

Oftentimes clients have accumulated assets that they originally intended to live on during their retirement. However, due to the success of their retirement planning, some of these assets may no longer be needed for retirement and focus can now be shifted to maximizing the transfer of wealth to heirs. Unfortunately, many assets that are attractive during the accumulation phase are inefficient wealth transfer vehicles.

One class of assets that is particularly inefficient for passing wealth to heirs are assets that have built-in ordinary income for which the tax burden will fall on the heirs. Assets intended to accumulate funds for retirement on a tax-deferred basis generally fit into this category. Another class of assets that may not be ideal for transferring wealth is what can be referred to as low-yield assets. These are “safe,” conservative assets intended to protect retirement savings. If preservation of retirement savings is not an issue, then such conservative assets may not be necessary and their ownership may result in sacrificing growth to the detriment of heirs.

Repositioning some of the identifiable inefficient financial statement items into more efficient assets can potentially assist your clients in passing on more wealth, especially if your clients will be subject to estate and/or inheritance taxes. One asset that can be attractive to reposition into is life insurance. For the following reasons, it has some potential advantages over other types of assets:

  1. The death benefit generally passes income tax-free to the designated beneficiaries;
  2. The annual premiums are generally considerably less than the death benefit, thus potentially providing substantial leverage; and
  3. It can be an easy asset to own outside the taxable estate without onerous gift tax consequences, because the gift is equal to just the annual premiums, which may fall within the client’s annual gift exclusions.

Inefficient assets that are not needed for retirement can be fully or partially liquidated and the proceeds can then be used to provide a potentially greater inheritance via the payment of premiums on a life insurance policy owned outside the taxable estate. Alternatively, additional leverage may be obtained by using the proceeds to purchase a single premium immediate annuity (SPIA) and using the income stream to pay the life insurance premiums.

Let’s take a closer look at some items on their financial statement that may reveal potential planning opportunities.

Low-yield Assets

This category includes assets such as corporate and government bonds and certificates of deposit (CDs). These assets are often part of a client’s portfolio because (1) they are relatively safe investments designed to preserve principal and (2) they provide a steady source of income. However, for clients who have sufficient income from other sources and don’t need the income from these types of assets, these clients may be sacrificing growth for the sake of safety. As illustrated by the following example, the opportunity exists to show these clients how they can reposition these assets in order to enhance what is passed to heirs without necessarily forgoing safety.

Hypothetical Muni-bond Example

Assume the following:

  • Client, age 68, has three children and a taxable estate of approximately $2 million.
  • He would like to maximize the amount of wealth transferred to his children. He is currently not making annual exclusion gifts to them.
  • He owns $300,000 in tax-free municipal bonds that are paying 4 percent interest.
  • Client has sufficient income from other sources and does not need the bond income.
  • Client is interested in repositioning his bonds to more efficiently transfer wealth to his heirs. He plans to systematically liquidate the bonds over a period of 10 years, which will produce a net cash flow of $35,561 annually.
  • This cash flow will be used to pay ten annual premiums on a guaranteed universal life insurance policy with a death benefit of $869,000.1
  • The life insurance policy will be owned outside Mr. Client’s estate in an irrevocable life insurance trust (ILIT). As a result, the proceeds will be received income tax and estate tax-free. Mr. Client will utilize his 2008 annual gift exclusion of $12,000 per child to cover the premium gifts (a total of $36,000 of annual exclusions is available).

Mr. Client’s life expectancy is approximately 18 years (age 86). At life expectancy, the bond value will be approximately $600,000. Assuming the bond value will be subject to estate taxes of 35 percent, the client’s heirs will net just under $400,000. This is less than half of what the heirs would potentially net if the bonds were repositioned into the $869,000 life insurance policy owned by the ILIT.

Without considering estate taxes, repositioning the muni-bonds into life insurance potentially produces a superior result through the client’s age 95. Moreover, if one takes into account estate taxes, the client’s heirs receive considerably more even if the client lives to age 100.

Because guaranteed universal life insurance was purchased, the client in this hypothetical example was able to reposition his conservative bond asset and potentially pass more wealth to his heirs without assuming substantially greater risk.

Tax-deferred Assets

Tax-deferred assets are typically associated with retirement planning, such as Individual Retirement Accounts (IRAs), qualified plans, and non-qualified deferred annuities These assets are inefficient wealth transfer vehicles primarily due to the fact that they have built-in ordinary income (income in respect of a decedent – IRD) that could reduce the net amount received by the heirs by 20 percent to 40 percent. In situations where estate taxes are also applicable, the net amount received by heirs may be reduced by as much as 70 percent.

Clients over age 59 1/2 who do not rely on their tax-deferred assets for current income may be better off liquidating the assets, paying the income taxes now, and repositioning the after-tax amount into life insurance owned outside their estate. Although pursuing this strategy (and paying the income taxes now) may appear to be unconventional, it may, in the long run, make more sense. Specifically, this approach removes the assets’ growth from the estate, as well as any deferred income tax liability associated with the growth. Repositioning these assets into life insurance owned outside the estate enables the client to convert tax inefficient assets into a tax-free asset, thus potentially enhancing their wealth transfer objectives.

Existing Life Insurance

Existing life insurance is another asset listed on the financial statement that may be enhanced to provide greater wealth transfer.

Due to continued improvements in mortality and the development of new types of products that did not exist 10­20 years ago (e.g., guaranteed universal life and indexed universal life), newer life insurance products may be more competitive than older ones. The opportunity exists to assist clients transfer more wealth to heirs by reviewing their existing permanent insurance to determine if they can obtain more death benefit for the same outlay.

In situations where the client either owns life insurance that is no longer needed for the reason it was originally purchased or simply can not afford to continue premium payments, it may be possible to sell the policy on the secondary market (i.e., enter into a life settlement transaction).2 This can help to create more wealth for heirs by ensuring that the existing life insurance asset does not become worthless upon lapse of the policy, or alternatively, that more value is potentially received from the secondary market than would be received if the policy were surrendered to the insurance company for its cash surrender value.

Trust Income

Thus far the focus has been on inefficient assets that may be listed on the financial statement. However, another area of the financial statement that should be reviewed for possible planning opportunities is the section dealing with sources of income. If the client is receiving income from an irrevocable trust and does not need it, this presents a possible opportunity to reposition trust assets to reduce or eliminate unneeded income while at the same time create more wealth for the remainder beneficiaries.

One example might be a situation where a surviving spouse, who has plenty of other assets, is the income beneficiary of a credit shelter trust (a.k.a., bypass or B trust). If the surviving spouse does not need the income, then its receipt may be creating adverse income tax consequences, not to mention unnecessarily increasing his or her taxable estate. It may be possible for the trust to accrue the income instead of paying it to the surviving spouse. However, since the top trust income tax bracket in 2009 kicks in at $11,150, this may not be a prudent option from an income tax standpoint.

A planning opportunity may exist to reposition trust assets by liquidating them over a period of time and using the proceeds to purchase life insurance owned by the trust. Since the cash value growth of permanent life insurance is tax-deferred, this eliminates the undesired current income tax consequences. In addition, the tax-free death benefit and the leverage provided by life insurance potentially enhance the value of the trust corpus that will be distributed to the remainder beneficiaries.

It is important when pursuing this planning opportunity to ensure that life insurance is a permissible investment of the trust. In addition, it important to ensure the life insurance will not be includible in the estate of the surviving spouse if he or she will be the insured (i.e., that the surviving spouse does not have incidents of ownership in the life insurance via being a trustee or having a limited power of appointment over the trust property).


As an advisor, you have the opportunity to provide additional value to those clients whose focus has shifted to maximizing wealth transfer. A simple review of a client’s individual financial statement may reveal opportunities to reposition existing assets into more efficient wealth transfer vehicles.

1 Guarantees are subject to the claims paying ability of the issuing insurance company

2 In a Life settlement transaction the seller receives a lump sum payment from the purchaser of a life settlement–typically for more than the policy’s cash surrender value but less than the net death benefit. As opposed to life insurance surrenders, they may take weeks or longer to complete. Please note that the number of bidders for a policy may be limited; proceeds from sales of similar policies may vary and may be subject to claims of creditors. Receipt of proceeds may impact eligibility for government benefits and entitlements. Prior to sale, the insured should consider the continued need for coverage, impact to estate plans, availability of insurance, cost of comparable coverage, and tax implications. There may be high fees associated with the sale of a life settlement and your personal medical information may be disclosed to 3rd parties.

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