The use of Life Insurance as a creditor-protected alternative to cash is a tactical strategy overlooked by many advisers and consumers. Below is a simple introduction to using life insurance to protect assets that’s increasingly important due to the economy and a hostile litigation environment.
- act today
- work with a qualified advisor
- use the right kind of life insurance policy
- get in writing how you can use the policy
- determine if this is economically efficient for you
- ignore carrier ratings and solvency risk
- over-fund the policy
- ignore legitimate business purposes
- ignore costs or the longevity of your money
- apply general information to your specific circumstances
The best asset protection is always implemented like insurance, before the problem happens. Even if the law says the asset is protected, you can’t covert it into protected status to evade a specific judgment or liability. The laws of most every state specifically excludes 11th hour transfers meant to delay, hinder or defraud a specific creditor.
The laws regarding creditor protection of life insurance vary from state to state, it’s best to consult with an advisory team that includes not only the right insurance advisor but the right lawyer who can provide an explanation of what state law requires and what options and exposures you may have regarding estate taxes. Many states require specific policy owners and beneficiaries to avail of legal protection, as just one example.
Not all life insurance policies are created equal. The right kinds of policies are high cash value, up to 100% liquid day one and have no lagging cash values or surrender charges. These are the fees that most insurance companies build into their policies to discourage early withdrawal or collapse of the policy. In some cases life insurance polices that have accepted large amounts of premium up front don't have a significant cash value equal to what you put into them for years, others have penalties of over 50% for withdrawals made in the first few years. Make sure your agent can explain which you have.
Make sure you are clear on what your policy structure looks like, how liquid it is, how soon you can make it liquid and if there are costs involved. Then get that detail from the carrier in writing. A promise of liquidity or an estimate of projected expenses without this is worthless. Look for policies that allow you to withdraw and if possible borrow large amounts of the premium from the policy without collapsing it or significantly reducing the death benefit.
With an insurance policy this is easy to identify, especially in today’s low-return-on- cash environment. As of this week, even an all-liquid asset like a 5 year CD is producing less than one percent annual returns. This means that an allocation on some of what you keep in cash to an alternative, like an insurance policy with annual returns as high as 2% net of the cost of insurance plus the death benefit itself, makes sense as an allocation to “cash”.
If you or your clients have this concern, look at options with “segregated accounts”. This may allow a choice to make the premium and cash value you have on deposit legally and physically distinct from the insurance carrier ‘s general account, and thus, realistically immune to even the carrier’s own solvency risk. This means your money is safe, even if theirs is not.
A natural inclination of most clients and advisors is to over-stuff any protective structure with anything they can shoe-horn into it. This is setting it up to fail. Most people have a “number” that makes sense, and makes them feel comfortable in their desire to have a certain amount of cash on hand for emergency and opportunity. Think about what that number is for you and allocate a reasonable portion of your cash to this strategy–not every dollar you have that’s not nailed down. For obvious reasons, anyone financially qualified to use a strategy like this should have significant cash and assets outside the structure, and should plan on this being a long- or medium-term allocation, not a revolving door or an alternative to a checking account.
The death benefit itself is an important legitimate business purpose. In many cases the HNW clients I deal with are under-insured in terms of their estate tax exposure, family income requirements, and the amount of coverage they have on their spouse. Make sure these amounts are adequate when determining what amount of death benefit is required and on whom. Don't forget that in many cases a strategy like this may be a great alternative to extended “term” insurance on primary family breadwinner during their peak earning years. When the loss of their labor and income would be the most devastating to the family’s financial plan.
Make sure you have a clear understanding, backed in writing, of the internal costs of insurance and estimates of how long the cash value will remain stable and level. Transferring large amounts of money into a policy as a “creditor protected cash alternative” makes no sense if the cash value plummets in a short period or in a period of time that is less than your reasonably need the protection to be in place.
The key to using a policy the right way in these states is to understand the exact letter of the law and to construct the policy so the owner and beneficiary are in line with what the state says is protected. These requirements and the protection afforded vary from state to state and may change often, so while online guides and articles that list creditor protection rules and strategies like this are a great place to start, you must look at the actual law as is currently memorialized by your state to be sure you have it right. Only when you have the law, the numbers and the advisors lined up do you have the information needed to determine if this strategy or any other is a good fit for you.
This article is meant to be an introduction to the use of life insurance in a tactical and specific way. There are countless nuances in policy construction and features, as well as the individual needs of those considering such a strategy. Hopefully this will be a starting point on your exploration of the options available and a slightly different way to think of life insurance as a creditor-protected asset class with merit in a low return, high liability business climate.