Is it time for a review?
By Joseph Faler, CLU, ChFC and Craig Mathiesen, CPA, MST 

Trust-owned life insurance – usually part of an Irrevocable Life Insurance Trust (ILIT) – has long been a popular estate-planning tool.  It provides tax-free dollars to one’s heirs at death which can replace assets lost to estate taxes and or assets left to charity.  However, life insurance is a unique entity and, as such, typically has been poorly managed by the trustees and advisors involved. 

Most trustees are familiar with the Uniform Prudent Investor Act (UPIA) and have implemented a process for managing investment assets in light of it.  One of the best ways to do this is with a formal investment policy statement (IPS).  An IPS is a document that outlines general investment goals and objectives of the trust and describes the strategies that should be employed to meet these objectives. Specific information on matters such as asset allocation, risk tolerance, and liquidity requirements would also be included in an IPS. 

Many trustees, however, have not created an IPS for managing trust-owned life insurance. The UPIA certainly applies to life insurance policies as much as it does investment assets such as stocks, bonds, or mutual funds.  This poses a serious problem for most trustees because they simply do not have an adequate process for analyzing trust-owned life insurance.

To comply with his or her fiduciary duties, a trustee must determine that the insurance policies owned by the trust are appropriate to meet the purposes of the trust. Term insurance, for example, is typically not appropriate for estate planning purposes because it is not permanent insurance and can (and probably will) expire prior to death.  The trustee must be able to determine if a fixed or variable contract is more appropriate to meet the purposes of the trust. 

While a variable contract holds the possibility of higher returns, it also contains an element of market risk that a fixed contract does not have.  The amount of death benefit must also be appropriate for the purposes of the trust. Often, the purpose of an irrevocable life insurance trust is to provide liquidity to pay estate taxes. If the amount of the death benefit is not sufficient to cover the estate tax, the “damages” to the client or the liability exposure to the trustee is the difference between the amount of estate taxes and the amount of life insurance. Trustees need to be aware of this issue because many trust-owned life insurance policies are at risk for being:

• unsuitable to the purposes of the trust 
• unreasonably priced or 
• under-funded

Improvements in life insurance

Many trust-owned life insurance policies are overpriced or underfunded because of the changing nature of insurance underwriting.   Several recent studies have found that beneficiaries are either receiving too little and/or are paying too much for the life insurance death benefit.   The good news is that life expectancy has increased over time, which has caused most insurance carriers to change their mortality tables and allowed the cost of life insurance to drop to all-time lows.  By performing a review of the trust-owned policy, trustees may see a dramatic improvement in the cost and amount of coverage available.  This may allow the trustee to improve on a current policy by:

• increasing coverage for the same cost 
• reducing the premium while maintaining the same level of protection or
• a combination of the above 

A review is in order

A fiduciary review of trust-owned life insurance may deliver better value for all involved, as well as uncover issues that can have unintended results. Perhaps the most important benefit will be the creation of an IPS and more realistic investor return expectations.  An insurance IPS should cover, among other things:

• the type of policy coverage to be purchased 
• the ratings required of life insurance companies 
• risk tolerance
• the premium schedule to which the policy should adhere 
• the purpose for coverage and statement of objectives
• asset guidelines

If you have a trust-owned life insurance policy, contact your financial advisor for a review of your current policy. They can make appropriate recommendations as to whether the amount needs to be increased or decreased or if there is a possibility to improve on the policy.

Any advice in this communication is not intended or written by  Rehmann to be used, and cannot be used by a client or any other person or entity for the purpose of:(I) avoiding penalties that may be imposed on any taxpayer or;(II) promoting, marketing or recommending to another party any matters addressed herein. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

Advisory services offered through Rehmann Financial, an SEC Registered Investment Advisor.  Securities offered through Triad Advisors, Member FINRA/SIPC.

This is not an offer to sell securities, which may be done only after proper delivery of a prospectus and client suitability is reviewed and determined.

Craig Mathiesen, CPA, MST, is a principal with Rehmann. He manages the estate, gift and trust tax practice and leads the Accounting, Consulting and Tax services group for the Farmington Hills office. Contact Craig at 248.579.1125or by emailing craig.mathiesen@rehmann.com.