A ll of us have, or should have, some life insurance. We may have some through our company or we may have some that we have purchased individually. Some of us are buying life insurance to protect our loved ones in the event of a premature death. Others are investing in cash value life insurance as a way to defer taxes on the growth of the policy (properly structured and maintained life insurance policies can see cash values grow tax-deferred and withdrawals and policy loans may also be accessed tax-free as well). The purpose of this article is to highlight some of the most common mistakes physicians make when buying life insurance. Then, we’ll explain some tax-efficient and creditor-proof ways to purchase life insurance. Of course, every situation is different, and we can’t diagnose your insurance situation without complete information. However, this article should motivate you to get an insurance check-up, which will hopefully save you some time, money and aggravation. Mistake #1 – The IRS May Get More than Half of Your Policy The greatest misconception most clients have when it comes to life insurance is that the proceeds are estate tax-free. This is absolutely wrong! The proceeds of life insurance policies are income tax free to the policy owner. The tax benefits do not necessarily pass down to the beneficiaries — unless they are the owners. Consider this example, and see if it sounds like your situation: A doctor, who’s also a father, buys a $1,000,000 life insurance policy. He pays premiums as scheduled and then, unfortunately, he and his wife die in an accident. The $1,000,000 is paid to the beneficiaries, the children. However, the $1,000,000 is included in the doctor’s estate and subject to estate taxes as high as $500,000 (As high as $550,000 after the year 2011 under current tax law). That’s right — roughly half of the insurance could go to estate taxes. Mistake #2 – Bad Judgment and Temptation May Ruin Inheritance Leaving money to your children in equal proportions may seem like the simple answer for a life insurance policy. This couldn’t be a bigger mistake. When you have young children, you may not want to leave the kids or their guardian with a very large pot of gold to spend at their discretion. It may not be that you don’t trust your brother or sister-in-law, but that you just don’t want to leave the temptation. Even if the guardian does a great job, you still need to ask yourself what you would have done with $500,000 or $1,000,000 if it had been given to you when you turned 18 or 21 years old. Suffice it to say, you might have spent it unwisely. Do you want to leave your children with those temptations? Of course not. Mistake #3 — Lawsuit or Divorce May Take Insurance Proceeds from Heirs If you leave money outright to children, their creditors may be able to take those funds. That’s right. You leave $500,000 to a child, and then that $500,000 is at risk in lawsuits. Even if your son isn’t an OB/GYN with significant liability from his work, he still could get divorced and lose half of the insurance policy proceeds. Wouldn’t it be nice to leave him money in a manner that protects it from lawsuits and divorce without requiring his spouse to sign a pre- or post-nuptial agreement? The Answer to Mistakes 1, 2 and 3 – The Irrevocable Life Insurance Trust An irrevocable life insurance trust (ILIT) is simply an irrevocable trust that owns a life insurance policy. Like all other irrevocable trusts, the ILIT requires a written document, a trustee, a beneficiary, and the terms of the trust distribution. A properly drafted ILIT should also have in its preamble that the purpose of the trust is tax savings involving a particular life insurance policy. You make gifts to the ILIT. The ILIT pays the premium to the insurance company. Then, the ILIT owns the policy that insures your life, the life of your spouse, or the joint lives in a second-to-die policy. The policy itself will name the trust as the owner and beneficiary so when you die, the insurance company pays the proceeds to the ILIT income and estate tax-free. This is how you get around the estate tax concern. Then the ILIT trustee will follow your trust instructions on what to do with the proceeds, including paying the ILIT beneficiaries you named in the trust document under your terms. You can have the children receive the proceeds at the age of 18, 25, 35, 65 or any age you like. You can only allow the children to have the funds if they graduate college, get a graduate degree, complete a religious mission, or accomplish any other (legal) task. You can have the funds pay out all at once or over time. While the funds are in the trust, they are protected from creditors (including spouses). This helps you protect the children from bad judgment, temptation and lawsuits. HINT: Having a corporate trustee as at least a joint trustee will cost you a few dollars (though some insurance-company-owned trust companies are rather inexpensive relative to banks and other trust institutions); however, the peace of mind and security of having a large institution implement your wishes (rather than a close family member) is often worth the cost. Before we move on to the tax savings and mistake four, let us recap the benefits of the ILIT. They include, but are not limited to, the following: • Estate Tax Avoidance. Avoid up to 50% lost to estate taxes. • Control of How Beneficiaries Use Funds. Avoid any temptation or bad judgment. • Protect Assets from Creditors and Divorce. Protect the heirs from themselves and from bad decisions. Now that we’ve shown you how to protect the kids on the back end, let’s show you how to save yourself some money on the front end. Mistake #4 — Not Taking Advantage of Tax-Efficient Purchase Options Did you know that there are tax-deductible group term life insurance programs for qualifying medical practices? Did you know that you could use up to 100% of your profit sharing plan dollars (if they are 5 years old) to purchase life insurance with pre-tax dollars? There are a variety of strategies that you can use for tax-efficient insurance purchases. However, these options are outside the scope of this article. Beware of plans that promise “tax-free life insurance” purchases. In February 2004, the United States Treasury issued guidelines regarding the use and valuation of life insurance in 412(i) Fully Insured Defined Benefit Plans and Section 79 Group Term Insurance Plans. The new regulations were scheduled to be issued until after the June hearings. Anyone who tells you that his plan for tax-free insurance purchases follows the new law can’t be telling the truth because the new laws haven’t been released. Like everything else, if you take time to understand the landscape, you can realize some great benefits. You can help yourself and your family by protecting them from lawsuits and taxes, and you may be able to legally reduce your taxes at least partially by implementing a plan for your practice or business.
Are You Making These Life Insurance Purchasing Mistakes?
A ll of us have, or should have, some life insurance. We may have some through our company or we may have some that we have purchased individually. Some of us are buying life insurance to protect our loved ones in the event of a premature death. Others are investing in cash value life insurance as a way to defer taxes on the growth of the policy (properly structured and maintained life insurance policies can see cash values grow tax-deferred and withdrawals and policy loans may also be accessed tax-free as well). The purpose of this article is to highlight some of the most common mistakes physicians make when buying life insurance. Then, we’ll explain some tax-efficient and creditor-proof ways to purchase life insurance. Of course, every situation is different, and we can’t diagnose your insurance situation without complete information. However, this article should motivate you to get an insurance check-up, which will hopefully save you some time, money and aggravation. Mistake #1 – The IRS May Get More than Half of Your Policy The greatest misconception most clients have when it comes to life insurance is that the proceeds are estate tax-free. This is absolutely wrong! The proceeds of life insurance policies are income tax free to the policy owner. The tax benefits do not necessarily pass down to the beneficiaries — unless they are the owners. Consider this example, and see if it sounds like your situation: A doctor, who’s also a father, buys a $1,000,000 life insurance policy. He pays premiums as scheduled and then, unfortunately, he and his wife die in an accident. The $1,000,000 is paid to the beneficiaries, the children. However, the $1,000,000 is included in the doctor’s estate and subject to estate taxes as high as $500,000 (As high as $550,000 after the year 2011 under current tax law). That’s right — roughly half of the insurance could go to estate taxes. Mistake #2 – Bad Judgment and Temptation May Ruin Inheritance Leaving money to your children in equal proportions may seem like the simple answer for a life insurance policy. This couldn’t be a bigger mistake. When you have young children, you may not want to leave the kids or their guardian with a very large pot of gold to spend at their discretion. It may not be that you don’t trust your brother or sister-in-law, but that you just don’t want to leave the temptation. Even if the guardian does a great job, you still need to ask yourself what you would have done with $500,000 or $1,000,000 if it had been given to you when you turned 18 or 21 years old. Suffice it to say, you might have spent it unwisely. Do you want to leave your children with those temptations? Of course not. Mistake #3 — Lawsuit or Divorce May Take Insurance Proceeds from Heirs If you leave money outright to children, their creditors may be able to take those funds. That’s right. You leave $500,000 to a child, and then that $500,000 is at risk in lawsuits. Even if your son isn’t an OB/GYN with significant liability from his work, he still could get divorced and lose half of the insurance policy proceeds. Wouldn’t it be nice to leave him money in a manner that protects it from lawsuits and divorce without requiring his spouse to sign a pre- or post-nuptial agreement? The Answer to Mistakes 1, 2 and 3 – The Irrevocable Life Insurance Trust An irrevocable life insurance trust (ILIT) is simply an irrevocable trust that owns a life insurance policy. Like all other irrevocable trusts, the ILIT requires a written document, a trustee, a beneficiary, and the terms of the trust distribution. A properly drafted ILIT should also have in its preamble that the purpose of the trust is tax savings involving a particular life insurance policy. You make gifts to the ILIT. The ILIT pays the premium to the insurance company. Then, the ILIT owns the policy that insures your life, the life of your spouse, or the joint lives in a second-to-die policy. The policy itself will name the trust as the owner and beneficiary so when you die, the insurance company pays the proceeds to the ILIT income and estate tax-free. This is how you get around the estate tax concern. Then the ILIT trustee will follow your trust instructions on what to do with the proceeds, including paying the ILIT beneficiaries you named in the trust document under your terms. You can have the children receive the proceeds at the age of 18, 25, 35, 65 or any age you like. You can only allow the children to have the funds if they graduate college, get a graduate degree, complete a religious mission, or accomplish any other (legal) task. You can have the funds pay out all at once or over time. While the funds are in the trust, they are protected from creditors (including spouses). This helps you protect the children from bad judgment, temptation and lawsuits. HINT: Having a corporate trustee as at least a joint trustee will cost you a few dollars (though some insurance-company-owned trust companies are rather inexpensive relative to banks and other trust institutions); however, the peace of mind and security of having a large institution implement your wishes (rather than a close family member) is often worth the cost. Before we move on to the tax savings and mistake four, let us recap the benefits of the ILIT. They include, but are not limited to, the following: • Estate Tax Avoidance. Avoid up to 50% lost to estate taxes. • Control of How Beneficiaries Use Funds. Avoid any temptation or bad judgment. • Protect Assets from Creditors and Divorce. Protect the heirs from themselves and from bad decisions. Now that we’ve shown you how to protect the kids on the back end, let’s show you how to save yourself some money on the front end. Mistake #4 — Not Taking Advantage of Tax-Efficient Purchase Options Did you know that there are tax-deductible group term life insurance programs for qualifying medical practices? Did you know that you could use up to 100% of your profit sharing plan dollars (if they are 5 years old) to purchase life insurance with pre-tax dollars? There are a variety of strategies that you can use for tax-efficient insurance purchases. However, these options are outside the scope of this article. Beware of plans that promise “tax-free life insurance” purchases. In February 2004, the United States Treasury issued guidelines regarding the use and valuation of life insurance in 412(i) Fully Insured Defined Benefit Plans and Section 79 Group Term Insurance Plans. The new regulations were scheduled to be issued until after the June hearings. Anyone who tells you that his plan for tax-free insurance purchases follows the new law can’t be telling the truth because the new laws haven’t been released. Like everything else, if you take time to understand the landscape, you can realize some great benefits. You can help yourself and your family by protecting them from lawsuits and taxes, and you may be able to legally reduce your taxes at least partially by implementing a plan for your practice or business.
A ll of us have, or should have, some life insurance. We may have some through our company or we may have some that we have purchased individually. Some of us are buying life insurance to protect our loved ones in the event of a premature death. Others are investing in cash value life insurance as a way to defer taxes on the growth of the policy (properly structured and maintained life insurance policies can see cash values grow tax-deferred and withdrawals and policy loans may also be accessed tax-free as well). The purpose of this article is to highlight some of the most common mistakes physicians make when buying life insurance. Then, we’ll explain some tax-efficient and creditor-proof ways to purchase life insurance. Of course, every situation is different, and we can’t diagnose your insurance situation without complete information. However, this article should motivate you to get an insurance check-up, which will hopefully save you some time, money and aggravation. Mistake #1 – The IRS May Get More than Half of Your Policy The greatest misconception most clients have when it comes to life insurance is that the proceeds are estate tax-free. This is absolutely wrong! The proceeds of life insurance policies are income tax free to the policy owner. The tax benefits do not necessarily pass down to the beneficiaries — unless they are the owners. Consider this example, and see if it sounds like your situation: A doctor, who’s also a father, buys a $1,000,000 life insurance policy. He pays premiums as scheduled and then, unfortunately, he and his wife die in an accident. The $1,000,000 is paid to the beneficiaries, the children. However, the $1,000,000 is included in the doctor’s estate and subject to estate taxes as high as $500,000 (As high as $550,000 after the year 2011 under current tax law). That’s right — roughly half of the insurance could go to estate taxes. Mistake #2 – Bad Judgment and Temptation May Ruin Inheritance Leaving money to your children in equal proportions may seem like the simple answer for a life insurance policy. This couldn’t be a bigger mistake. When you have young children, you may not want to leave the kids or their guardian with a very large pot of gold to spend at their discretion. It may not be that you don’t trust your brother or sister-in-law, but that you just don’t want to leave the temptation. Even if the guardian does a great job, you still need to ask yourself what you would have done with $500,000 or $1,000,000 if it had been given to you when you turned 18 or 21 years old. Suffice it to say, you might have spent it unwisely. Do you want to leave your children with those temptations? Of course not. Mistake #3 — Lawsuit or Divorce May Take Insurance Proceeds from Heirs If you leave money outright to children, their creditors may be able to take those funds. That’s right. You leave $500,000 to a child, and then that $500,000 is at risk in lawsuits. Even if your son isn’t an OB/GYN with significant liability from his work, he still could get divorced and lose half of the insurance policy proceeds. Wouldn’t it be nice to leave him money in a manner that protects it from lawsuits and divorce without requiring his spouse to sign a pre- or post-nuptial agreement? The Answer to Mistakes 1, 2 and 3 – The Irrevocable Life Insurance Trust An irrevocable life insurance trust (ILIT) is simply an irrevocable trust that owns a life insurance policy. Like all other irrevocable trusts, the ILIT requires a written document, a trustee, a beneficiary, and the terms of the trust distribution. A properly drafted ILIT should also have in its preamble that the purpose of the trust is tax savings involving a particular life insurance policy. You make gifts to the ILIT. The ILIT pays the premium to the insurance company. Then, the ILIT owns the policy that insures your life, the life of your spouse, or the joint lives in a second-to-die policy. The policy itself will name the trust as the owner and beneficiary so when you die, the insurance company pays the proceeds to the ILIT income and estate tax-free. This is how you get around the estate tax concern. Then the ILIT trustee will follow your trust instructions on what to do with the proceeds, including paying the ILIT beneficiaries you named in the trust document under your terms. You can have the children receive the proceeds at the age of 18, 25, 35, 65 or any age you like. You can only allow the children to have the funds if they graduate college, get a graduate degree, complete a religious mission, or accomplish any other (legal) task. You can have the funds pay out all at once or over time. While the funds are in the trust, they are protected from creditors (including spouses). This helps you protect the children from bad judgment, temptation and lawsuits. HINT: Having a corporate trustee as at least a joint trustee will cost you a few dollars (though some insurance-company-owned trust companies are rather inexpensive relative to banks and other trust institutions); however, the peace of mind and security of having a large institution implement your wishes (rather than a close family member) is often worth the cost. Before we move on to the tax savings and mistake four, let us recap the benefits of the ILIT. They include, but are not limited to, the following: • Estate Tax Avoidance. Avoid up to 50% lost to estate taxes. • Control of How Beneficiaries Use Funds. Avoid any temptation or bad judgment. • Protect Assets from Creditors and Divorce. Protect the heirs from themselves and from bad decisions. Now that we’ve shown you how to protect the kids on the back end, let’s show you how to save yourself some money on the front end. Mistake #4 — Not Taking Advantage of Tax-Efficient Purchase Options Did you know that there are tax-deductible group term life insurance programs for qualifying medical practices? Did you know that you could use up to 100% of your profit sharing plan dollars (if they are 5 years old) to purchase life insurance with pre-tax dollars? There are a variety of strategies that you can use for tax-efficient insurance purchases. However, these options are outside the scope of this article. Beware of plans that promise “tax-free life insurance” purchases. In February 2004, the United States Treasury issued guidelines regarding the use and valuation of life insurance in 412(i) Fully Insured Defined Benefit Plans and Section 79 Group Term Insurance Plans. The new regulations were scheduled to be issued until after the June hearings. Anyone who tells you that his plan for tax-free insurance purchases follows the new law can’t be telling the truth because the new laws haven’t been released. Like everything else, if you take time to understand the landscape, you can realize some great benefits. You can help yourself and your family by protecting them from lawsuits and taxes, and you may be able to legally reduce your taxes at least partially by implementing a plan for your practice or business.
