Summer 2012
In This Issue • Why the Insurance Industry has a Monopoly on Retirement • The Importance of a Unified Message • Bridging the Knowledge – Action Gap before the Ball Drops • The Washington Report in the Quarterly
Summer 2012
Features Main Office 11921 Freedom Drive, Suite 1100 Reston, Virginia 20190 (703) 641-9400 Capitol Hill Office 101 Constitution Avenue, NW, Suite 703 East Washington, DC 20001 (202) 742-4638 AALU CEO | David J. Stertzer Editor James E. Lee Design & Production Carolyn Schmid Editorial Board Matt Anderson Kathleen W. Bilderback, J.D., LL.M. Lee Nunn, CPA Deborah L. O’Neil, J.D., CFP, CLU Marc P. Schwartz, J.D. Richard Zacharoff, CLU, ChFC. CFP
4 The AALU President’s Message David A. Culley, CLU, ChFC 8 The 2012 AALU Presidential Speech 40 The 2012 Annual Meeting FAQs 42 The 2012 Annual Meeting Facts 44 The New AALU Washington Report 50 The 2012 Gerald H. Sherman Award
CONTENTS 7 The AALU Welcomes 80 New Members 12 Bridging the Knowledge - Action Gap Before the Ball Drops By: Michael Fontanini, CLU, CFP & Matthew Fitch, JD, CLU
Staff Contributors David J. Stertzer Emily Adelman Justin Brown Marc Cadin Jarrett Fischer Brendan Gleason Carrie Green Laura Henry Elizabeth Jarvis Karla Kirk Tom Korb, J.D. Grant Lebens James E. Lee Danielle Manno Marilyn Maticic Ashlee Morris Chris Morton Sinduja Prem Anthony Raglani Carolyn Schmid Kevin Tangney
20 Estate Planning for Family Farms and Ranches By: Louis S. Shuntich
Photography Steven Purcell Carolyn Schmid
59 Legislative Circle Program
26 The AALU Issues Alliance 28 The Installment Sale Buy-Sell: A Risky Proposition For Business Owners By: Peter McCarthy and Maggie Mitchell, ING U.S. Insurance 34 The AALU and NAILBA Stronger Together By: Dexter Umekubo & Steven J. Finkle 26 The AALU Issues Alliance 52 The Importance of a Unified Message The AALU Advocacy Notecard 56 Why the Insurance Industry Has a Monopoly on Retirement By: Tom Hegna CLU, ChFC, CASL
The Association for Advanced Life Underwriting
The AALU President’s Message Welcome to the Summer edition of the AALU Quarterly and what is shaping up to be a very active second half of 2012. As I write this column in early July, we’re only four months from the November elections that could have a tremendous impact on the direction of our nation’s economy and our profession. Regardless of your personal preference, a win by President Obama or Governor Romney presents unique challenges to our clients and our industry. At the June Board of Directors meeting, we had a great discussion about what the likely election outcomes will mean for our members and our clients. For example, a President Obama reelection could mean a continued focus on regulatory actions that might impact us. A win by Gov. Romney could mean more legislative debate on estate tax reform. No matter who wins the election, Congress will have to act to prevent taxes from increasing and the federal budget from being slashed under the recent budget agreement. That could take lead to comprehensive tax reform, including efforts to change the tax treatment of life insurance. All of these outcomes have the potential to significantly impact our clients and profession. And the best way to ensure our voices are heard by the Congressional leaders who will make the decisions is to ensure we have as many AALU members fully engaged in our advocacy programs as possible. As I shared with AALU Members who attended the Annual Meeting, the AALU has been criticized in the past for crying “wolf” too often.
4 Summer 2012 The AALU Quarterly
That’s understandable. The issues we cover have grown from 1 or 2 every 2-3 years to multiple issues every year. If we knew when, where and how the next attack on our products and services was going to occur, I’m confident we would have a waiting list of producers wanting to join the AALU. Members would line up to build relationships with critical Congressional leaders and staff, raise funds for endorsed candidates and be totally engaged.
what it takes to protect our profession. I’d like to acknowledge two volunteer Committee leaders and two Board members who have been working overtime to advocate for our clients and members: •
Dave Byers and his Ambassador Committee, the team responsible for increasing the number of highlevel relationships we need with key members of Congress.
•
Rick Ray and his LCP Committee, the team responsible for increasing the number of members who contribute to our PAC and endorsed candidates as well as the amount of the contributions.
•
Board Member Chris Foster – Chair of the Board’s Government Affairs Committee, the Board Committee that oversees all of our Advocacy efforts and issue positions.
•
Board Member Tim Malarkey – Chair of the Life Insurance Task Force, the Special Committee responsible for helping us plan for the variety of contingencies that we face as the issues mentioned above come into play.
But our challenge is this – we don’t know when this attack is going to occur, only that it will happen. This is not unlike the challenges we face in our practices every day. How many times has one of your clients or prospects asked you: “What’s the best life insurance policy for me? The standard answer, of course, is “Tell me when you are going to die, and I will design the perfect policy for you.” We must design a policy that provides benefit if death occurs tomorrow - or 25 years from tomorrow. This is the major challenge in our individual business and the AALU. We have to be able to design our life policies and our industry advocacy plans to meet the needs of our clients, and protection of our industry for today, tomorrow and years from now. Some in the new Congress will not know us, but we need to help them understand our value and vital role we play for millions of families and businesses. And, every one of us has a story to tell that will help Congress make better decisions. That’s not crying wolf. That’s just doing
I look forward to working with you this next year to grow our membership and help protect our profession. Get in touch with me today at
[email protected] to find out how you can get more engaged.
David A. Culley, CLU, ChFC AALU President “Sic Vos Non Vobis”
DaviD a. Culley, Clu, ChFC Nease, Lagana, Eden & Culley, Inc.
At a time when leadership is needed most, Dave Culley has answered the call. Please join us in congratulating Dave Culley, the 13th AALU President from the M Community, who continues M Financial Group’s legacy of leadership and commitment to clients. Dave has been a member of the AALU Board since 2005, working to protect our industry and preserve our ability to serve families and businesses. As a Principal of Nease, Lagana, Eden & Culley, Inc., an M Member Firm in Atlanta, Dave advocates for his clients by developing and delivering sustainable solutions. Dave’s term as President of AALU comes at a critical time for our country and our industry and we are fortunate to have him at the helm. Please give Dave—and the entire AALU leadership team—your support as we work together to reach new heights. We salute Dave for stepping forward from a community of leaders to set an example for others to follow. On behalf of the entire M Community, we extend our congratulations and thanks to Dave for his exemplary service.
www.mfin.com The Association for Advanced Life Underwriting
Whoʼs recruited the most AALU members this year? New York Life (65) Independents (44) MassMutual (33) Northwestern Mutual (18) M Financial (9) Guardian (7) Metlife (6) Lincoln Financial (5) National Financial Partners (5) Principal Financial Group (5) Prudential (5)
Where are the most AALU Members? M Financial Northwestern Mutual New York Life
0.0 0.2 0.4 0.6 0.8 1.0
MetLife
National Financial Partners
John Hancock
Pacific Life
PennMutual
Guardian
44
44
42
42
42
AXA
247
232
228
6 Spring 2012 The AALU AALU Quarterly Quarterly 6 Summer 2012 The
186
144
135
84
Valmark Securities
MassMutual PartnersFinancial
60
The AALU Welcomes 80 New Members! As of June 30, 2012
Linda Allen Wellesley Hills, MA
Jerry Corless Memphis, TN
Christopher Kelm San Antonio, TX
Rebecca Pressgrove Bloomington, MN
Russell Atkinson Ridgeland, MS
Matthew Curran New Haven, CT
Thomas Krach Dublin, OH
Lucas Quaccia Deerfield, IL
Ray Avrett Scottsdale, AZ
Timothy Dardis Sioux Falls, SD
Steven Larson Austin, TX
Gary Ranftle Syosset, NY
Dennis Axman Orange Park, FL
Thomas Deleot Winston Salem, NC
Gary Levin Tampa, FL
Thomas Ruane Kansas City, MO
Jason Bach Dallas, TX
Scott Della Penna Vienna, VA
Paul Ludacka Omaha, NE
Rebecca Ryan Chicago, IL
Bracknell Baker South Natick, MA
Matthew Dobbie Camp Hill, PA
Matthew Lueder Milwaukee, WI
Gary Sancilio Albany, NY
C. Barrier Glen Allen, VA
Brian Domoretsky Boston, MA
Patrick McCraw Alpharetta, GA
Justin Smith Newport Beach, CA
Drew Besonson Troy, MI
Rafael Ekstein Brooklyn, NY
Henry McCray Atlanta, GA
Art Sobczak Independence, OH
Toby Bishop Edina, MN
Michael Emery Grand Rapids, MI
Gregory McRoberts Indianapolis, IN
John Blanks Roanoke, VA
Darin Fass White Plains, NY
David Means Minneapolis, MN
Greg Blum Syosset, NY
David Frank Houston, TX
John Miller New York, NY
Joseph Borsellino San Juan Capistrano, CA
Barbara Gill Southfield, MI
Dwight Moldenhauer Buffalo, NY
Troy Braswell Overland Park, KS
Alan Grad New York, NY
Karen O’Beirne Wellesley Hills, MA
Gregory Straka Atlanta, GA
Steven Burgess Salt Lake City, UT
Dean Gregory Downers Grove, IL
John Ocwieja Chicago, IL
John Waters Reading, MA
Clay Carter Austin, TX
Marc Ham Roseville, CA
David Odom San Antonio, TX
Mark Carter Okemos, MI
Stacy Hammond San Francisco, CA
Gregory Olsen New York, NY
Jason Cavalier Westlake Village, CA
Brian Hurley Plymouth, MA
Paul Park Pomona, CA
Richard Clark Lancaster, PA
Nicola Iannitelli Fairport, NY
Ralph Peeples Jackson, MS
Edward Colello Brooklyn, NY
Anthony Luffredo New York, NY
David Perlmutter New York, NY
Fredric Collins Charleston, SC
Jonathan Jaramillo Sleepy Hollow, NY
Robert Perry Farmingdale, NJ
Stacy Cooley Carr Austin, TX
Paul Karlitz New York, NY
Robert Petrocelli New York, NY
Brad Somma Woodbury, NY Eric Spindt Portland, OR Roger Stacy Cincinnati, OH
Sharon Welch-Blair Little Rock, AR Michael Williams Penfield, NY Tom Yaeger Los Angeles, CA Amanda Zukowski Austin, TX
Do you know someone who should be an AALU member? Contact Jarrett Fischer at 703.641.8120 and/or
[email protected] for more information or to request an application. TheThe Association for for Advanced LifeLife Underwriting 7 Association Advanced Underwriting
On Tuesday, May 1, 2012, David A. Culley was elected as the 55st president of the AALU. Here are excerpts from his address to the Annual Meeting.
C
hange has been an integral part of the AALU since that “band of renegades” first got together 55 years ago.
and vibrant life insurance marketplace for our clients and members.
By the time Man walked on the Moon, we had grown to 600 members...on our way to more than 2,200 members four decades later.
we’re created these past 55 years.
That’s not an either or proposition. It’s an imperative that we recruit new members AND we grow engagement.
Nat Perlmutter helped ensure we have an engaged leadership team, starting with the Board and expanding back to the past presidents and Board members and extending into the future with more engaged committee chairs. Gib Surles helped grow engagement in the existing membership, helping to reduce our attrition rate to the lowest level in a decade by showing the benefits of being personally involved. And now, it’s time to grow our membership and get them engaged in helping ensure our elected leaders and their staffs understand the
You know, the AALU has been criticized in the past for crying “wolf” too often. That’s understandable. Our group is not a passive or meek membership. If we knew when and where the next attack on our products and services was going to occur, I’m confident we would have members standing in the hallways at this meeting. They’d line up to raise funds for endorsed candidates…build relationships with critical Congressional leaders and staff…and be totally engaged.
And the changes we’ve witnessed are only accelerating, but the improvements we’re about to make to the way the AALU delivers value are just that - improvements - that will deliver more and better information the way our members want so we can all become better at our craft and serving our clients. What is not going to change is our core mission: ensuring we have a strong
8 Summer 2012 The AALU Quarterly
To continue to succeed at our mission, we need to build on the foundation
consequences of their actions on the families and businesses that rely on life insurance.
The Association for Advanced Life Underwriting
But our challenge is this – we don’t know when or where this attack is going to occur, only that it will happen.
For five years we advocated for the reunification of the gift and estate tax – an action Congress took in 2010.
This is not unlike the challenges we face in our practices every day. How many times has one of your clients or prospects asked you: “What’s the best life insurance policy for me?”
Small businesses and families can plan today as opposed to waiting until death to utilize their exemption.
How many of you have heard that? The standard answer, of course, is “Tell me when you are going to die, and I will design the perfect policy for you.” This always creates a laugh with the client and we agree, of course, that no one knows when they are going to die. So we must design a policy that provides benefit if death occurs tomorrow…or 25 years from tomorrow. This is the major challenge in our individual business and the AALU. We have to be able to design our policies and our advocacy plans to meet the needs of our clients…and protection of our industry today, tomorrow and years from now. Some in the new Congress will not know us…but we need to help them understand our value and vital role we play for millions of families and businesses. And every one of us has a story to tell that will help Congress make better decisions. That’s not crying wolf. That’s just doing what it takes to protect our profession. We’ve taken on very tough issues these last ten years - and succeeded. We’ve flipped the “death tax” debate to reasonable estate tax reform that is now the basis for our tax law.
10 Summer 2012 The AALU Quarterly
We took on regulatory reform issues that could have strangled our business. This summer, our staff and members met with FINRA, met with the SEC and testified before Congress to advocate for our position. In each of these efforts, we won battles, but are they over? Of course not. But you, I, and our clients are in a much better place with our products and services because of our efforts. In every one of our past challenges, a number of our members initially thought what we were doing was too risky or they wanted other groups to advocate our position. This reminds me of a lot of fans watching a high school or college basketball game. We have all been there at the end of a close game. With the clock running down, someone takes a long jump shot and we all say, “No…No…No!” When it goes in, we all say, “Good shot!” For the players and coaches who are engaged in the game, that is not a risky shot because they have practiced it over and over again. But for those folks in the stands who are merely watching, it appears risky. One hundred and two years ago, almost to the day, former president Teddy Roosevelt recognized this.
In one brief passage in a speech in Paris... President Roosevelt made it clear that personal involvement - being engaged being the “Man in the Arena” is the best course of action: “It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.” I’m grateful to be able to serve as your president for the next year...come join me in the arena.
The Association for Advanced Life Underwriting
12 Summer 2012 The AALU Quarterly
Bridging the KnowledgeAction Gap Before the Ball Drops Get Your High-Net-Worth Clients off the Fence before 2012’s Golden Opportunity Goes Away By: Michael Fontanini, CLU, CFP Assistant Director, Advanced Sales Training, & Matthew Fitch, JD, CLU, Advanced Markets Consultant, The Hartford, Individual Life
When the ball drops at year’s end in Times Square, make sure your clients haven’t dropped the ball in terms of their tax planning. Until the end of 2012, clients can take advantage of the $5.12 million lifetime gift exemption. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRA 2010) created an unprecedented wealth transfer opportunity for your high-net-worth clients. It increased the lifetime gift tax exemption from $1 million to $5.12 million per person for 2012; reduced the top marginal transfer tax rate to 35% for taxable gift, estate and generation skipping (GST) transfers; reunified the lifetime gift and estate tax exemptions; and established
portability for the married. It allows clients who make a large gift in 2012 to:
and nearly 40% have never discussed their legacy goals at all.1
• Remove future appreciation from the taxable estate • Reduce future estate tax exposure • Set aside funds for future wealth transfer costs, thereby enabling them to protect illiquid assets
Additionally, the study found that many of today’s wealthy haven’t prepared their children for a future inheritance because they question the child’s ability to handle an inheritance, fear the children will lose ambition, or could potentially fall prey to scams or squander the money.
Despite these potential advantages and even when clients understand that wealth transfer makes great financial sense for their heirs, clients are failing to act. Half the affluent clients in a 2011 U.S. Trust survey have never discussed with their financial advisor how to help their family handle the emotional aspects of wealth
With such obvious financial opportunities being lost to inertia, it seems the gap between the wealthy clients’ goals and their actions comes not from a lack of knowledge or even will, but rather one or more subtle emotional conflicts. Once you can help your high-net-worth clients identify this “emotion gap,” you can then bridge it and move them to action. The Association for Advanced Life Underwriting
Gap #1: Loss Aversion - Loss aversion is the strong tendency to prefer avoiding losses to acquiring gains. Though the theory applies mainly to investment risk, your client might perceive a large gift as a financial loss to himself or herself, with the benefit – however clear and unambiguous - accruing largely to others. How you can bridge the Loss-Aversion Gap – Leveraging a tax advantage is not the same as taking an investment risk. In fact, maintaining ownership of assets that will be taxed in the future is akin to managing it for the U.S. Treasury, until the IRS comes to collect its share. Perceived loss of control by gifting may be “bad,” but the “good” of maintaining ownership is not without pitfalls of its own. Gap #2: The Familiarity Syndrome – Let’s face it; parents have seen it all when it comes to their grown children. From diapers to discipline, tuition to bailouts, they have performed all the costly, and often thankless, acts of parenthood. If the (now adult) children are doing well, any call for further sacrifice may be met with skepticism. How you can bridge the FamiliaritySyndrome Gap – Removed from the stringent duties of parenthood, the older generation is now interested in the talents and development of the youngest generation – the grandchildren. With the benefit of wisdom, your clients may now be interested in using part of their wealth to shape their grandchildren’s destinies. For the financial planner, this is a compelling client concern that can be a powerful call to action. Gap #3: Idealization of Status Quo – The financial situation for which your wealthy clients have sacrificed and worked so hard and now enjoy represents their ideal. Any proposal that alters this long-sought status quo – 14 Summer 2012 The AALU Quarterly
their ideal – may be difficult for them to embrace. How you can bridge the Idealization of Status - Quo Gap – Clients need to see that wealth transfer planning is not intended to overturn the status quo, but rather to enhance and secure it. In this window of opportunity, you can educate clients on the true potential of estate planning and the critical role that trusts can play in this strategy: • Protect assets from nuisance lawsuits, divorcing spouses, or creditors • Provide for beneficiaries who lack the maturity to manage wealth • Establish controls to ensure trust assets are used according to the client’s wishes • Reinforce your client’s values by rewarding beneficiaries to “follow the rules” Once you’ve identified the emotion gap of your high-net-worth clients, you can then move intellectually-ready but emotionally-
inert clients to action, knowing you are integrating their values with their financial strategies. Following are four examples of trust arrangements that can provide both certainty and flexibility for the older, wealthy generation. The Dynasty Trust If your client intends to establish a family endowment for the benefit of the grandchildren and great-grandchildren, putting the future in economic perspective may be helpful. For example, the average annual cost of attending a private nonprofit undergraduate institution was $34,725 in 2009-2010.2 For a child born today, assuming 3% annual cost inflation, the same education will cost well over $200,000. For a grandchild born in 20 years, it’s not hard to imagine this may be over $400,000. The overall growth in cost for services may cause safety nets to diminish. Social Security and Medicare long-run actuarial deficits worsened in 2012.3 Observers expect Medicare, in particular, to experience substantial cost growth in the coming decades, due to aging of the population and growth in expenditures
“We’re so confident we can help your business thrive, the first year is on us.”* — Leon Monroe, Vice President, The Monarch Group
Individual Life Insurance
SAY HELLO TO LEON. AND MORE ACCESS THAN EVER BEFORE. Meet Leon Monroe, Vice President of The Hartford Monarch Group.® This membersonly group of top life professionals guarantees direct access to our award-winning innovations, progressive underwriting, and compensation that parallels your commitment. Gain direct access today by calling Leon at 404.316.5577 or visiting thehartford.com/monarchgroup.
*The Hartford will contract new 2012 Monarchs at its highest payout for the Monarch’s first 12 months of production. The Hartford Monarch Group consists of select independent producers who are contracted with The Hartford. Guarantees and benefits within the policy are based on the claims-paying abilities of the issuing insurance company. Broker/Dealers, insurance agencies and their affiliates who sell the policy make no representations or guarantees regarding such ability. “The Hartford” is The Hartford Financial Services Group, Inc. and its subsidiaries, including the issuing companies of Hartford Life Insurance Company (HLI) (New York) and Hartford Life and Annuity Insurance Company (HLA) (outside New York), Simsbury, CT. The mailing address for both issuers is P.O. Box 2999, Hartford, CT 06104-2999. LIF110582-1 06/12
The Association for Advanced Life Underwriting
DIRECT ACCESS TO UNLIMITED SUCCESS In The Hartford Monarch Group,® we know exceptional life professionals deserve exceptional service. That’s why this members-only program offers unprecedented access to the resources you need to help your business grow even further. Unlike many competitors, our focus doesn’t stop at your top line. As an independent producer, you know that managing your bottom line is just as vital as your growth. That’s why we feature a complete suite of business-building benefits like advanced markets training, Wealthy and Wise® software, deferred compensation, annualized commissions, rewards that reflect your success, and much more.
“Direct access is vital in our business. That’s why you can call me directly at 404.316.5577.” — Leon Monroe, Vice President, The Monarch Group
“In The Monarch Group, we believe every day is an audition. If you want direct access, give me a call at 404.316.5577 or visit thehartford.com/monarchgroup.” – Leon INNOVATIVE PRODUCTS AND SERVICES Only The Hartford Monarch Group offers you direct access to patentpending products and services, including Issue First,® an awardwinning process that transforms the traditional 48-day wait into 48 seconds. Give your eligible clients immediate coverage while you get immediate closure.
PROGRESSIVE UNDERWRITING
UNPARALLELED COMPENSATION
As a Monarch, you don’t just get access to an underwriter – you get your own underwriter. Having a partner who understands your clients’ situations helps you offer the best rates possible. And, our preferred crediting was acknowledged by Best’s Review’s Innovators Showcase. Rest assured, your clients’ underwriting needs are in experienced and dependable hands.
We know you can choose where you place your business. As a top life professional, your commitment to your clients not only deserves the best support available, but also the best compensation and incentive package available. We’re so confident we can help your business thrive, the first year is on us.*
*The Hartford will contract new 2012 Monarchs at its highest payout for the Monarch’s first 12 months of production. The Hartford Monarch Group consists of select independent producers who are contracted with The Hartford. Guarantees and benefits within the policy are based on the claims-paying abilities of the issuing insurance company. Broker/Dealers, insurance agencies and their affiliates who sell the policy make no representations or guarantees regarding such ability. “The Hartford” is The Hartford Financial Services Group, Inc. and its subsidiaries, including the issuing companies of Hartford Life Insurance Company (HLI) (New York) and Hartford Life and Annuity Insurance Company (HLA) (outside New York), Simsbury, CT. The mailing address for both issuers is P.O. Box 2999, Hartford, CT 06104-2999. Wealthy and Wise® is a registered trademark of Insmark. LIF110670-1 06/12
16 Summer 2012 The AALU Quarterly
per beneficiary exceeding growth in per capita GDP3. This cost growth may result in increased taxation and, most likely, a reduction in benefits. However, proper planning may create the self-security that clients want to protect future generations, who may not have access to the same level of protection from social support programs that are available today. With a Dynasty Trust, for generations to come, your client can: • • •
Avoid estate tax exposure on trust assets Protect trust assets from creditors, divorce and mismanagement among beneficiaries Control how trust assets are used and distributed to beneficiaries
The Dynasty Trust acts to leverage the clients’ generation-skipping transfer tax exemption (GSTT): $5.12 million in 2012. The GSTT is levied on property transfers to persons two or more generations younger than the transferor. It is designed to disallow “skipping” estate taxation on the middle generation. The GSTT rate is equal to the highest marginal estate tax rate at the time of the transfer: currently 35%. By allocating the GSTT exemption to a lifetime gift in trust the client can create a Dynasty Trust which can allow future trust distributions to be exempt from estate and GST taxes. If the trustee is given discretion over distributions, trust assets can typically be protected from the claims of beneficiaries’ creditors, including a divorcing spouse, business or financial creditor, or plaintiff in a nuisance lawsuit. By establishing special conditions, the trust can also permanently reinforce your clients’ value system and
ensure trust assets are received and managed according to his/her wishes for generations to come. Such provisions can be vital in helping protect your clients’ hard-earned wealth and ensuring a legacy of values is transferred beyond a legacy of financial wealth. Provisional gifts via Incentive Trusts can instruct the trustee to:
consulted to ensure the trust provisions prevent distributions in satisfaction of any legal obligation of spousal support on the part of the grantor. If the trust is properly drafted to preclude this from occurring, the trustee’s power to make distributions to the spouse should not cause trust assets to be included in the grantor’s estate.
• • • • •
But what if the spouse beneficiary dies
Reward beneficiaries who meet academic standards or graduate from college Distribute amounts only in relation to a beneficiary’s W-2 to encourage work ethic Avoid distributions to those who develop substance abuse problems or are convicted of illegal activities Provide bonus income to those who pursue a worthy but lower-paying career, such as public service Provide a cheaper source of capital to beneficiaries wishing to fund college, buy a home or start a business
Spousal Lifetime Access Trust (SLAT) With a SLAT, your clients can: • Keep trust assets out of their estate for estate tax purposes, including life insurance death benefits • Provide the non-grantor spouse, as a trust beneficiary, the flexibility to receive trust assets, including life insurance cash values, at the discretion of the trustee allowing gifted monies to be returned to the family unit The spouse-beneficiary can have an income interest in the trust and receive distributions of principal, therefore ensuring household access to trust property. However, a qualified advisor should be
first? With a single SLAT, the grantor loses access to trust values when the spousebeneficiary dies. A solution to this dilemma can be “his-and-her” SLATs using life insurance where each spouse makes a gift to a separate irrevocable trust with the other as a beneficiary. After the gift, the trustee purchases life insurance on the grantor’s life. While both are alive, each has access to the assets of the other’s trust, including life insurance cash values. When a grantor dies, his or her trust is funded with the death benefit, ensuring continued access for the other spouse. Gifts of $5.12 million each, with each trust purchasing $10.24 million of death benefit, can ensure that when either spouse dies, the trust value is equal to the initial combined gift amount plus the accumulated value of trust assets not used for insurance premiums. Additionally, assets can be distributed to other beneficiaries during life or after death, per the trust terms. The clients need to be careful, though, not to trigger application of the so-called reciprocal trust doctrine, which could result in the trust assets being included in the spouses’ estates. Generally speaking, there are two things necessary to avoid creating reciprocal trusts. First, the two trusts may not be interrelated, meaning“…substantially identical in terms and … created at approximately the same time … [and] part of a single transaction.” The Association for Advanced Life Underwriting
- United States v. Estate of Grace, 395 U.S. at 325 (1969). Second, the trusts must alter the economic positions of the grantors. In other words, if the grantors are in approximately the same economic position as they would have been in had they created trusts naming themselves as life beneficiaries, the trusts may be reciprocal. Many advisors believe that by adding a limited power of appointment to one of the trusts, the reciprocal trust doctrine may not apply. (See Private Letter Ruling 200426008 for more information on the reciprocal trust doctrine.) Gift and Note Sale with an Intentionally Defective Grantor Trust (IDGT) With a gift and note sale to an IDGT, your client can: • Transfer and create signifi cant amounts of wealth outside the estate without gift tax consequences • Receive interest income • Be repaid over 90% of the initial total transfer amount typically within three or nine years • Retain managerial control over assets Under this strategy, instead of gifting $10 million for example, the clients make a much smaller “seed” gift and sell, or “loan,” $10 million to an IDGT, in exchange for an interest-only balloon note. The “seed” gift generally should be at least 10% of the initial principal value of the note. The note itself is typically structured with a term between three and nine years and its interest rate must be equal to or greater than the Applicable Federal Rate (AFR), or the deficiency is an imputed gift. The assets sold typically produce income, which the IDGT trustee uses to pay interest to the grantor. The trustee also repays the note principal at the end of the term using 18 Summer 2012 The AALU Quarterly
interests of the asset itself or other trust assets. Any excess trust income or assets can be used to purchase life insurance or reinvested for beneficiaries. Note interest income and principal repayment can result in the client recovering over 90% of the initial total transfer amount (total transfer = 10% seed gift plus asset value). Alternatively, at the end of the term the grantor and the IDGT could renegotiate the note with a new term and interest rate to continue the strategy, if desired. Also, the client could use available annual exclusions and/ or lifetime exemption as gifts to the trust to reduce the note balance at a later point. These alternatives can provide the flexibility to make future adjustments to the plan based on future circumstances. If non-controlling interests of an LLC or similar entity are sold, the client can also retain managerial control over the asset. The trust is called “intentionally defective” because it includes one or more powers known as grantor trust powers described in the Internal Revenue Code, such as the power to add trust beneficiaries. The result is the grantor being liable for payment of income taxes generated by the IDGT (i.e. grantor taxation). Properly drafted, such powers will NOT cause estate inclusion which means asset values in excess of note principal/interest amounts will transfer free of estate tax (any outstanding note balance at death is includible in the client’s estate). Although recognized for estate tax purposes, transactions between the grantor and a grantor trust are disregarded for income tax purposes; hence no capital gain taxes on the sale and no income taxes on interest received (IRS Revenue Ruling 85-13). Lastly, intentionally causing grantor taxation can have significant wealth transfer benefits. The value is that trust income can be reinvested and distributed
at gross, not net, amounts providing greater benefit to trust beneficiaries. At the same time, the grantor can reduce the estate and, thus, future estate taxes by the income tax amounts (“tax burn”). Payment of trust income taxes is not a taxable gift nor is the sale of an asset to the trust. Trust Loans to the Grantor With a Loans-to-Grantor Provision, your client can: • •
Give the trustee the discretion to make loans to the grantor, without triggering estate inclusion of trust assets themselves Have access to a source of capital from the trust
If an irrevocable trust is drafted to give the grantor the right to trust income or principal, the value of the trust would typically be included in the taxable estate. Such an arrangement would defeat the purpose of the trust. However, giving the trustee the discretion to lend money to the grantor is an exception to this rule. Assuming the trustee satisfies his or her fiduciary obligations to the beneficiaries, a loan-to-grantor provision could allow the client to access trust assets, including life insurance cash values, without causing adverse estate tax consequences. In fact, if your client dies with the debt outstanding, the taxable estate is further reduced by that amount. The loan should require a market rate of interest and adequate collateral. The Opportunity When the ball drops in Times Square on Dec. 31, it will mark the start of a new year, and, the expiration of your clients’ opportunity to benefit from the highest-ever $5.12 million lifetime gift tax exemption. While we cannot speculate
on the fate of tax proposals, President Obama’s 2013 budget*** includes: • Decoupling the estate and gift tax lifetime applicable exclusion amount • Reducing the lifetime gift limit to $1 million • Disregarding valuation discounts for certain restrictions on intra- family transfers • Making the intentionally defective grantor trust (IDGT) extinct by including the assets of a trust in the gross estate of the grantor for estate tax purposes, to the extent the income tax rules treat a grantor of a trust as an owner of the trust
While not all these provisions may pass, the current fiscal reality may leave lawmakers little choice but to move away from current rates and limits. The result is that 2012, in hindsight, may be seen as a golden opportunity for many of your highnet-worth clients. So we put this question to you: Will this be an opportunity that you help your high-net-worth clients seize or will it be one that passes them by? Sources: 1 . U.S. Trust Insights on Wealth and Worth™, 2011 survey of affluent individuals with $3 million or more in investable assets.
This information is written in connection with the promotion or marketing of the matters addressed in this material. The information cannot be used or relied upon for the purpose of avoiding IRS penalties. These materials are not intended to provide tax, accounting or legal advice. As with all matters of a tax or legal nature, your clients should consult their own tax or legal counsel for advice. “The Hartford” is The Hartford Financial Services Group, Inc. and its subsidiaries, including the issuing companies of Hartford Life Insurance Company (New York) and Hartford Life and Annuity Insurance Company (outside New York), Simsbury, CT. The mailing address for both issuers is P.O. Box 2999, Hartford, CT 06104-2999. Distributed by Hartford Equity Sales Company, Inc. (HESCO), a broker/dealer affiliate of The Hartford. LIF111068-3 6/12
. U.S. Department of Education, National Center for Education Statistics, Higher Education General Information Survey (HEGIS). Includes tuition and fees, room and board. 2
. http://www.ssa.gov/oact/trsum/index.html
3
ABOUT THE AUTHORS Michael Fontanini
has been in the insurance and financial services industry for over 10 years with background as a financial advisor, life insurance wholesaler and home office employee with roles in marketing, advanced sales training and product development. He is a Certified Financial Planner (CFP) and Chartered Life Underwriter (CLU) with a passion for advanced planning and sales strategies. While with New England Financial, as a financial advisor, he specialized in estate planning for families having children with special needs. He then joined Phoenix Life as a life insurance wholesaler where he partnered with financial advisors to help them grow their life insurance business by meeting the life insurance needs of their clients. Later, he accepted a position at Phoenix’s home office where he was responsible for product marketing, sales training and product development. Michael joined The Hartford in 2010 where he is now responsible for advanced sales training. He was born and raised in Iowa, graduated from the University of Iowa and now resides in West Hartford, CT. In his free time, Michael enjoys snowboarding, mountain biking and golf.
Matt Fitch, J.D., CLU
, is an Advanced Markets Consultant with The Hartford’s Individual Life Division. Matt Joined The Hartford in 1999 as an illustration systems consultant and transitioned to the Advanced Markets role in 2009 after receiving his Juris Doctor from the University of Connecticut School of Law. His specialty is advanced case design support and consultation, but he has frequent roles in marketing, training, and illustrations initiatives. Matt completed his undergraduate studies at the University of Connecticut and resides in Hartford, CT.
Life insurance policies contain fees and expenses, including cost of insurance, administrative fees and premium loads, surrender charges and other charges or fees that will impact policy values. Variable universal life insurance policies also have additional charges and fund operating expenses. Guarantees and benefits within the policy are based on the claims-paying ability of the issuing insurance company. Broker/dealers, insurance agencies and their affiliates who sell the policy make no representations or guarantees regarding such ability. LIF112053 08/12 The Association for Advanced Life Underwriting
20 Summer 20 Spring 2012 2012 The TheAALU AALUQuarterly Quarterly
Estate Planning for Family Farms and Ranches By: Louis S. Shuntich
The problem Farmers and ranchers are typically strapped for cash so when one of them dies leaving an estate large enough to be exposed to the federal estate tax the family can expect to have to sell something to cover the tax. That does not have to be the case. The estate tax has been described as a “voluntary” tax. Voluntary, that is, if you are willing and able to take advantage of the planning opportunities that are in the law. If not, life insurance can be a very appealing alternative to having to sell the family farm. Marital Deduction There are several strategies that can be employed to ease or eliminate the federal estate tax burden. At the most basic level, a married farmer or rancher can postpone any estate tax until the death of their surviving spouse by utilizing the unlimited estate tax marital deduction. This is because since 1981 that deduction exempts from tax any property that the decedent leaves to their surviving spouse. Of course, any of that property which is still remaining in the surviving spouse’s hands at his or her death will be exposed to tax but at least the couple gets to postpone any tax until the second death.1
By-Pass Trust Even though the marital deduction is a great estate planning opportunity it is also a trap for the unwary. That is because while a taxpayer can avoid any estate tax on their death by simply leaving all of their property to their spouse, such an approach may cause an unnecessary increase in estate tax at the surviving spouse’s death. The reason is that the first spouse to die would not be properly utilizing their applicable estate tax exclusion amount. To avoid this problem an individual’s Will is usually drafted to provide that property equal to their applicable estate tax exclusion be placed in what is called a “By-Pass” trust with the remainder of the estate given to the surviving spouse under the marital deduction. This approach still avoids any estate tax at the first death because the amount in the By-Pass Trust is shielded by the applicable estate tax exclusion while the balance is covered by the marital deduction. The individual’s spouse should not be concerned about losing access to the amount in the By-Pass Trust. According to the Trust’s terms, all the income can go to the spouse and the trustee can have the discretion to pay the spouse as much of the principal as necessary. Further, the spouse can have the right to demand the greater
of $5,000 or 5% of the Trust principal each year. By taking the By-Pass Trust/Marital Deduction approach, the advantage becomes apparent when the surviving spouse dies. The value of the property in the By-Pass Trust will not be included in the spouse’s estate and will not be subject to estate tax. The is because the spouse will not be deemed to own the property in the Trust and only property that the spouse owns at death is subject to the estate tax. So, whatever is left in the By-Pass Trust, at the spouse’s death, can go to the couple’s children or other beneficiaries free of estate tax. What will be taxed at the surviving spouse’s death will be the amount of property that the spouse has in excess of the spouse’s own estate tax applicable exclusion. This figure will be comprised of the spouse’s own separate property plus what remains of the property that the spouse received under the marital deduction. The advantage of employing the By Pass Trust in combination with the marital deduction as opposed to giving all the property to the surviving spouse may be seen from the following example: The Association for Advanced Life Underwriting
Unlimited Marital Deduction First Death in 2011 $15,120,000 Gross estate $15,120,000 Marital Deduction $0 taxable Estate Second Death in 2012 $15,120,000 Gross Estate •
Assume that the first spouse dies in 2011 with an estate of $15,120,000. In 2011 the applicable exclusion amount was $5M
•
Assume further that the surviving spouse has no separate property and dies in 2012 when the application exclusion amount is $5,120,000 As the above example demonstrates, $1,750,000 of estate tax can be saved on the second death by dividing the estate between the marital deduction and the By-Pass Trust. It should be noted, that if the surviving spouse had actually died first their estate tax applicable exclusion would have been wasted. This is because that spouse would have had no separate property with which to set up a By-Pass Trust if they died first. To solve that problem the spouse with all the property should consider giving an amount of property equal to the estate tax applicable exclusion to the spouse with nothing. (For this purpose you should note that the gift tax marital deduction would prevent any gift tax from applying to such a transfer as long as the spouse is a US citizen.) That would assure the same over all estate tax savings whichever spouse died first. Alternatively, in some situations and depending on State law a joint trust is advantageous so the wealthy spouse does not need to give up full control during their life. Portability This is a new concept to the federal estate tax that was introduced by the 2010 tax act. Basically it allows the executor of a deceased person’s estate to transfer any of their unused estate tax exclusion to their surviving spouse. The problem is that the 22 Summer 2012 The AALU Quarterly
Marital Deduction / By-Pass Trust First Death in 2011 $15,120,000 Gross Estate $10,120,000 Marital Deduction/$5,000,000 By-Pass $0 Taxable Estate Second death in 2012 $10,120,000 Gross estate portability provision only applies to those dying in 2011 and 2012. Therefore if a person relies on portability and it is not in effect at their death after 2012, their estate tax exclusion is wasted. This means that those writing wills in 2011 and 2012 are not likely to rely on portability and risk wasting their estate tax exclusion.2 Special use valuation of farm or small business property. The second basic estate tax saving technique that is available to farmers and ranchers pertains to the special use valuation of farm or ranch property. This is because in 1976 Congress enacted Internal Revenue Code section 2032A finding it desirable to encourage the continued use of real estate for farming, ranching and other small business purposes. Prior to the passage of section 2032A, real estate that was included in a decedent’s estate was valued at its fair market value. Consequently, where the realty was used for farming, ranching or other small business purposes, including it in the estate at fair market value often created a substantially higher estate tax liability than was warranted, considering the value of its use as a farm, ranch or small business operation. Section 2032A permits real estate that qualifies to be valued in the estate on the basis of its actual use rather than its higher fair market value. This means that when the provision applies, it grants relief to the heirs of farmers, ranchers and small business owners who wish to carry on the family business and might otherwise find that fair market value produces such a large estate tax that they have to sell the property to pay the tax.
There is a $1,040,000 limit per decedent for 2011 on how much the real estate may be reduced from its fair market value to its actual use value. For example: •
Assume that the estate of a decedent contains qualifying farmland with a fair market value of $1,500,000 that is worth $400,000 as a farm.
•
It will be included in the estate at a value of $460,000. This is because while the difference in value is $1,100,000 the maximum reduction is only $1,040,000 (as adjusted for inflation).
•
Here it should be noted that between a husband and wife the total reduction in value after both deaths is two times $1,040,000 or $2,080,000.
The problem with section 2032A (like other tax saving provisions) is that it requires certain conditions to be met. Even where those requirements can be complied with, the parties may consider them too onerous to be worth the tax benefit. Among the stipulations for 2032A to apply are the following: •
The decedent must be a resident or citizen of the United States.
•
The property can only pass to certain members of the decedent’s family.
•
The decedent or a member of the decedent’s family must have owned the property and materially participated in the operation of the farm or business for 5 of the 8 years
before and after the decedent’s death. •
The value of the real and personal property used in the farm or business must comprise at least
•
50% of the value of the decedent’s gross estate.
•
At least 25% of the value of the decedent’s gross estate must be represented by the value of the farm or small business real estate.
•
If the decedent’s family disposes of the property or ceases to use it in the prescribed manner for
•
the required period, the tax benefits are recaptured through the imposition of an additional tax.
While the theory of 2032A is not difficult to understand, it is extremely complicated to apply in practice. If you have a client who is contemplating the use of 2032A to minimize estate taxes, have them seek the necessary expertise. Installment payment of estate tax on farm, ranch or closely held small business property. If more than 35% of a decedent’s adjusted gross estate consists of an interest in a farm, ranch or other closely held business, the executor may elect to defer payment of the estate tax attributable to the farm or business for 5 years (paying interest only), and thereafter pay the tax in equal installments over the next 10 years. In addition, pursuant to the 1997 tax act for decedents dying after 1997, interest is imposed at a 2% rate on the first $486,500 of tax (for 2012) The rate imposed on the balance of the deferred tax is reduced to 45% of the rate applied to underpayments of tax. As previously stated, to qualify for this benefit under Internal Revenue Code section 6166, more than 35% of the decedent’s estate must be comprised of the interest in the farm, ranch or other closely held business. In applying this rule it does not matter whether the interest is
held as a proprietorship, partnership or corporation. It must, however, be operated as an active trade or business since a passive rental of property does not count. In any case, the problem with section 6166 is that like section 2032A it puts limits on the family’s use and disposition of the property in question. Because of taxpayer noncompliance with payment obligations the IRS has imposed onerous requirements, such as a surety bond, that mean that section 6166 is no longer a feasible strategy. Estate tax saving through gifting Beyond the basics of the marital deduction, 2032A and 6166 the next level of estate planning begins with the understanding that individuals with estates in excess of the estate tax applicable exclusion (and married couples with twice that amount) face the possibility of federal estate tax liabilities upon their deaths. In that regard, the only way to avoid the tax is to dispose of the excess before death or to leave it to charity at death. As to dispositions before death, for those who can afford it, a lifetime gifting program provides a means of estate tax savings while enjoying the personal satisfaction that comes from helping others. The problem, however, is that the donor is exposed to gift tax on the transfers. That may be mitigated however, through the use of the donor’s annual gift tax exclusion and their lifetime applicable exclusion amount. The gift tax annual exclusion and $5.12 million lifetime applicable exclusion The gift tax “annual exclusion” is simply a rule that allows a person to gift to as many people as they want each year $13,000 gift tax free in 2012 and this amount is indexed. Further, if they are married and their spouse consents in making the gift the couple can transfer $26,000 to as many individuals as they choose gift tax free. For example, a couple with three children could give each child $26,000 for a total of $78,000 gift tax free. The lifetime “applicable exclusion” is a rule that permits individuals to give $5.12 million transfer tax free either during their life or at death during 2012. This means that any of the applicable exclusion
amount used during a taxpayer’s life will reduce the amount that can pass without estate taxes. This $5.12 million is in addition to what can be given away using the annual exclusion. For example, assume that a married couple gave each of their three children $54,000 for a total of $162,000. This would result in a gift to each child of $28,000 in excess of the amount that the parents can give tax free by utilizing their combined annual gift tax exclusions ($54,000 - $26,000). To avoid having to pay a gift tax on the $28,000 excess to each child, the parents would offset the excess against their $5.12 million gift tax applicable exclusion. Since each parent’s share of the excess would be $14,000 per child (1/2 of $28,000) and there are three children, the reduction in each parent’s gift tax applicable exclusion would be 3 x $14,000 or $42,000. Further, for every year that the gifts are repeated, each parent’s gift tax applicable exclusion would drop by another $42,000. Consequently, if the gifts were continued for ten years, each parent’s gift tax applicable exclusion would be reduced by 10 x $42,000 or $420,000. Note that pending Congressional action the lifetime applicable exclusion is scheduled to drop to $1 million after 2012. Gifting at a discount With the above gifting opportunities in mind it is apparent that a farmer or rancher can significantly reduce the size of their estate and consequent estate tax exposure through a gifting program to their heirs using the annual exclusion and $5.12 million applicable exclusion. Moreover, farmers and ranchers may also leverage the annual exclusion and $5.12 million applicable exclusion by repackaging the farm or ranch property that is to be given away in a business structure that allows discounts to be taken against the value of the gift for lack of marketability and lack of control. The idea behind leveraging with discounted gifts is to structure the transfer in a way that allows the value of the gift to be reduced before applying the gift tax annual exclusion and the $5.12 million gift tax applicable exclusion. This means that more farm or ranch property can be transferred for the same amount of annual exclusion The Association for Advanced Life Underwriting
and $5.12 million lifetime applicable exclusion. Unfortunately discounts have been under scrutiny by the government as a potential revenue raising measure so although they are available now it must be watched carefully to determine if they will be available in the future. Family Partnerships To gain an understanding of how this concept operates, assume that a married couple owns among other assets a large farm worth $20,000,000 that they would like to pass on to their three children. If the parents were to form a family partnership in 2012 and transfer the farm to the partnership in return for partnership interests, they could make transfers of partnership interests to the children by gift. Partnerships have been under scrutiny by the IRS for some time so working with a competent professional is key to ensure that transfers will qualify for the annual gift tax exclusion and that the parents are not deemed to remain as owners of the whole partnership due to retained control.
Gifting to the children In making gifts to the children the parents can choose to make outright gifts of the partnership interests using their annual gift tax exclusions and $5.12 million gift tax applicable exclusions. Depending upon the facts of the case, the value of the interests transferred to the children may be substantially reduced for the lack of marketability and lack of control discounts. These marketability and control discounts relate to the fact that a stranger to the family would not pay full price to acquire an interest in a family partnership for which there is not a ready resale market and in which they would have a noncontrolling interest. From a leveraging perspective, what this means is that the discounts allow the parents to magnify the amount of farm or ranch property that they transfer to the children gift tax free through utilization of their annual exclusions and gift tax applicable exclusions. For example, if upon establishing the family partnership described above, the parents were able 24 Summer 2012 The AALU Quarterly
to give the children partnership interests equal to the parent’s combined annual exclusions and $5.12 million gift tax applicable exclusions at a 35% discount, the children would receive $15,873,846 of undiscounted partnership interests. Without the discounts the parents could only have transferred $10,318,000 gift tax free ($10,240,000 of the parents’ combined $5.12 million gift tax applicable exclusions in 2012 plus $78,000 of their combined gift tax annual exclusions for the year = $10,318,000). Consequently, the discounts allow the parents to transfer an additional $5,555,846 of undiscounted value using the same amount of annual exclusions and $5.12 million gift tax applicable exclusions. Further, in subsequent years the parents could continue to make tax free discounted gifts by utilizing their annual gift tax exclusions even though their $5.12 million gift tax applicable exclusions are used up. This would have a dramatic impact on the reduction of the parents’ potential estate tax liabilities without generating any gift tax. Grantor Retained Annuity Trust (“GRAT”) Beside making direct gifts to the children of interests in the family partnership the farmer or rancher can transfer the partnership interests to a trust and retain a right to income from the trust for a period of time. After the expiration of the farmer’s or rancher’s income period the remainder interest in the trust assets (partnership shares) passes to the family member(s). The value of the remainder interest is a gift to the family member(s). This is a useful approach where the farmer or rancher wants to give the property to the family member(s) but would like to retain a right to income for a period of time. For example, assume that in 2012 Bill at age 65 transferred $1 million of family partnership interests to a GRAT retaining the right to receive 4% or $40,000 per year for 10 years • •
Assume further that the present value of Bill’s right to income is worth approximately $350,000 The gift of the remainder to family members is worth ap proximately $650,000 and may
•
be offset against his $5.12 million lifetime gift tax exclusion If the trust assets earn 7% per year the family will receive ap proximately $1,400,000 at the end of 10 years
It should be noted that if the farmer or rancher dies during the income period, some or all of the property will be brought back into their gross estate. To offset any possible estate tax that might result the farmer or rancher can buy a term insurance policy for the duration or the income period in an amount sufficient to cover any possible estate tax. Sale of the farm or ranch to the family member(s) Alternatively, the actual property or partnership shares may be sold to the family member(s) using an installment sale, self-canceling installment note, sale to a defective grantor trust or a life insurance funded buy - sell agreement. Installment sale Under this approach the farmer or rancher sells the property or partnership shares to the family member(s) for a series of installment notes. It is appropriate where the farmer or rancher has used up their gift tax exclusions or they want to receive income payments during retirement. The farmer or rancher may purchase life insuranceon the family member(s) to cover the possibility that the purchaser(s) will die before all the installments are made. Self-canceling installment note This is also an installment sale situation. What is different is that the family member(s) pays a premium for the right to have any unpaid installments canceled at the farmer’s or rancher’s death. This would keep any unpaid installments out of the farmer’s or rancher’s estate for federal estate tax purposes although there may be inclusion of any unrecognized capital gain. Again, the farmer or rancher should insure the life of the purchaser(s) to cover the possibility that the purchaser(s) will die before all the installments are paid. Installment sale to a defective grantor trust
This approach involves the farmer or rancher setting up a trust that has certain provisions that cause the trust’s income tax consequences to be reported to the farmer or rancher. The trust is for the benefit of the family member(s) who is to receive the property or partnership shares. The farmer or rancher generally seeds the trust with a gift of income producing assets that is offset by their $5.12 million gift tax exclusion. The farmer or rancher then enters into an installment sale with the trust. (The rule of thumb is that for every dollar gifted to the trust the trust may purchase ten dollars of property or partnership interests from the farmer.) The trust then pays off the installment notes with the income from the gifted and purchased assets. The result is that since the farmer or rancher is treated as the owner of the trust for income tax purposes, it is as though the farmer or rancher sold the property or partnership shares to themselves and consequently he or she should recognize no taxable gain on the sale. Since the sale is not recognized for income tax purposes the basis to the property to the trust will be the carry-over basis. Buy-sell agreement The farmer or rancher and the family member(s) enter into a life insurance funded buy-sell agreement. If the sale takes place during the farmer’s or rancher’s business life the cash value of the policy can serve as a down payment with the rest of the sales price are completed with installment payments. If it is a sale at death the death proceeds cover the purchase price. Note that due to the flexibility of buy-sell
agreements as an exit strategy tool they may also be used with co-owners and outsiders as well as family members. Life Insurance – the Palatable Alternative Finally, let’s talk about the effects of the farmer’s and rancher’s increasing age on attitudes toward estate tax planning. The issue is that going forward fewer and fewer farmer’s and rancher’s are likely to be interested in rearranging their affairs to save taxes on their children’s inheritances. This is because as the baby boomers age they will not like change and estate tax reduction techniques typically involve creating changes in how property is owned and managed as well as making large gifts to the next generation. The result is that not liking change and the making of large gifts necessitates that professional advisors find a palatable alternative for these farmer’s and ranchers with taxable estates. In that regard, an alternative is to purchase life insurance through an ILIT. That is because:
lowest tax possible. It must be recognized, however, that not everyone has the inclination to engage in estate tax saving techniques that require changing their lives and making large gifts. Fortunately, for those who are not predisposed to complicated tax planning, life insurance provides a palatable alternative. This is because it does not require that they upset their lives and is cost efficient while providing the necessary funds to pay estate taxes when they are needed upon the person’s death. Sources 1 The unlimited marital deduction is not available for non-citizen spouses. 2 See Washington Report 12-30 for more details Guarantees are based on the claims-paying ability of Lincoln Benefit Life Company, Lincoln, NE a wholly-owned subsidiary of Allstate Life Insurance Company, Northbrook, IL.
The examples in this article are hypothetical and for illustrative purposes only. Customers should seek professional
• It does not require changing the farmer’s or rancher’s life. • Premiums are an affordable al ternative to large estate reducing gifts.
guidance on their particular situation. Results are not necessarily indicative of future performance or success.
This information is provided by Lincoln Benefit Life (LBL), Home Office, Lincoln, NE. The information provided is for general educational purposes and is not intended to provide legal, tax, or investment advice. LBL issues fixed and variable
Summary In closing, it must be understood that the objective of estate planning is not to just focus on saving taxes. Rather, the goal should be for the farmer or rancher to do what they should to take care of themselves and their families and then with proper planning to do that at the
insurance products that are sold through agreements with affiliated or unaffiliated broker-dealers or agencies. Allstate Distributors, L.L.C. serves as principal underwriter of certain SEC-registered contracts for LBL.
FOR BROKER/DEALER OR AGENT USE ONLY— Not for public dissemination. May not be distributed, reprinted, or shown to the public in oral, written, or electronic form as sales
ABOUT THE AUTHOR Louis S. Shuntich
is Senior Vice President, Advanced Planning with Lincoln Benefit Life Company. Mr. Shuntich has degrees from Rider University (B.S. Cum Laude), The College of William and Mary (J.D.) and New York University (LL.M in Taxation). A Certified Retirement Counselor, Mr. Shuntich holds licenses in life, health, variable annuities as well as Series 6 and 63. Mr. Shuntich is a member of AALU’s Busines Insurance and Estate Planning Committee (BIEP) and NQ Plans Broad Committee. In addition, Lou is the author of five books on advanced marketing subjects.
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The Installment Sale Buy-Sell: A Risky Proposition For Business Owners By: Peter McCarthy and Maggie Mitchell, ING U.S. Insurance
M
any business owners expect to
sell their ownership interest during their lifetimes. In fact, some see selling their business interest as a practical way to fund their retirements. Although sellers prefer to be paid in a lump sum, many buyers won’t have enough cash to pay the full purchase immediately. Consequently, many buy-sell agreements are structured with the buyer making an initial down payment and then paying the balance to the seller over a specified number of years. The buyer also pays interest on the remaining balance at the rate specified in the agreement. In many installment sales the buyer is counting on business profits to provide the cash needed to pay both the principal and the interest.
For most buyers, an installment sale is similar to quite similar to getting a bank loan to pay the purchase price. In an installment sale, however, the buyer is borrowing from the seller rather than from a bank. In both cases, the buyer is taking on a new liability and promises to pay what is owed over a period of years plus interest. The financial impact on the buyer is the same regardless of whether the payments are made to a bank or to the seller. From the seller’s standpoint, however, there is a big difference. In an installment sale, there are a several ramifications and risks to the selling owner (or if the owner has died, the seller’s heirs) that are not present in a lump sum sale.
Inflation Will Reduce the Spendable Value of the Payments. Many sellers aren’t aware that inflation works against them in an installment sale. Even if the installment payments are made on time and everything goes as planned, the seller suffers financially in an installment sale. That’s because when the seller receives the purchase price in increments over several years, inflation will reduce its purchasing power. The lost purchasing power can be significant. The true impact depends on several factors, including: the year-to-year inflation rate, the amount of principal paid each year, and the number of years over which payments are made. For example, suppose Joe Smith is paid $500,000 plus interest for the purchase of The Association for Advanced Life Underwriting
his interest in ABC, Inc. The money will be paid in 10 equal installments of $50,000 plus interest. If the inflation rate is 3% each year during this ten year period, The total purchasing power of the $500,000 paid to Joe is only $426,510, a loss of $73,490 which is about 15% of the $500,000. See Appendix A for a yearto-year summary. The interest due on the outstanding balance isn’t designed to make up for the impact of inflation. Rather, interest is a charge to the buyer for the use of the seller’s money. It is designed to replace what the seller could potentially have earned on the unpaid balance if the purchase price had been paid in a lump sum. Just as inflation reduces the purchasing power of the principal paid in future years, it will also reduce the purchasing power of the interest paid on the unpaid principal payments. New Risks To The Seller. In addition to the impact of inflation of the spendable value of the payments, the seller may assume a number of other risks by participating in an installment buy-sell arrangement. Some of these additional risks include: 1. The Seller May Still Be Liable For Business Debts. Just because a business owner sells his ownership interest doesn’t necessarily end his/her responsibility for business debts. If the seller has signed some type of personal guarantee (as is often the case with business loans from banks), the seller may still be personally liable if the business defaults on the loan. Savvy sellers usually try to negotiate a release of their personal guarantees when they sell their business interests. Also, some buyers will specifically structure the buy-sell agreement so current business debts will remain the seller’s responsibility. In these cases the sale is designed as an “asset sale.” The buyer doesn’t purchase 30 Summer 2012 The AALU Quarterly
the seller’s stock or ownership interest. Instead, the buyer only purchases selected business’ assets and thereby leaves the liabilities as the seller’s responsibility. 2. The Impact of Taxes and Rising Tax Rates. The seller must consider the impact of taxes on the installment payments. For income tax purposes each payment is generally divided into three parts: (1) return of basis, (2) capital gains on growth in excess of basis and (3) interest on the unpaid principal balance. The return of basis portion of the payment is usually income tax-free. However, principal growth over basis is generally taxed at capital gains rates and interest is usually taxed at ordinary income rates. Thus, the seller needs to consider that the installment payments may generate several different federal and state taxes. During the term of the installment payments, the seller has the risk that the federal and state governments could increase some or all of the applicable tax rates. 3. The Business May Not Be Able To Produce Enough Money For the Buyer To Make the Payments. When the buyer will be using business profits to make the payments to the seller, it is possible there won’t be enough money. Because the installment payments are usually a significant new expense, the business will likely have to increase the revenues it generates if there are going to be enough after-tax profits to make the payments. Increasing business revenues and profits can be difficult after an owner has left the business. The buyer must have both the skills and the discipline to operate the business profitably over the number of years that installment payments are to be made. 4. Future Events Could Reduce the Buyer’s Ability To Make the Payments. Even if everything looks good at the time the installment sale is made, future events could take place during the payout period
which may reduce the buyer’s ability to make the promised payments. For example: a. The buyer may die unexpectedly b. The buyer may become sick or disabled c. Key employees could leave the business d. The economy and business environment could falter (e.g. recession) e. New developments, technologies or competitors may reduce business revenues or cash flow (e.g. the impact of digital cameras on Polaroid and Eastman Kodak) f. The business could incur unexpected liabilities (e.g. injury to a customer or employee) g. Natural disasters may damage the business’ earning capacity or adversely impact important customers and thereby reduce the revenues they can afford to spend Business owners who sell their ownership interests in installments need to be cognizant of these risks. If the buyer is unable or unwilling to make the promised payments, the selling owner may have to go to court to protect his/her rights. If the buyer defaults, the seller may have to find another buyer or take back the business and operate it personally. Neither alternative is usually attractive. Wise sellers do the best they can make sure the buyer is reliable and has the ability to run the business profitably. They also negotiate buy-sell terms that are realistic and achievable by the new owner. Suggestions For Sellers. At first glance, installments sales can appear to be relatively easy ways for sellers to exit their businesses. A closer examination, however, shows there sellers assume some serious new risks when they agree to an installment sale. Many things
could go wrong during the installment payment period. But there are some strategies sellers can potentially use to protect themselves, including:
upfront and reducing the size and/or the term of the installment payments.
1. Try to avoid an installment sale—the seller can insist that the buyer get a bank loan or use other sources of funds to make a lump sum purchase. If the buyer borrows money to finance the purchase, the seller should avoid giving a personal guarantee.
3. Get a Personal Guarantee From the Buyer—just as banks demand personal repayment guarantees of the owners when they make business loans, sellers can also ask for the buyer’s personal guarantee. If the buyer defaults, a personal guarantee may permit the seller to access the buyer’s non-business assets to get paid.
2. Negotiate a Larger Down Payment and/or a Shorter Payment Period–-The potential impact of inflation on the seller’s purchasing power can be significant when the principal is paid over time (Review Appendix A). Even if the installment sale is completed as planned, the Seller will still suffer a loss of purchasing power from inflation. If an installment sale is the only way to fund the purchase, the seller should try to reduce his/her risk by getting more
4. Insist on an “Indemnification” Clause— Seller should negotiate with lenders and other creditors to eliminate personal liability after he/she sells his interest. In the event lenders or creditors are unwilling to do so, the buy-sell agreement can include a provision in which the business and/or the remaining owners agree to pay back to (indemnify) the seller for any funds he/she is forced to pay to lenders or creditors under their personal guarantees.
5. Focus on Funding the Agreement— Business owners often pay more attention to the terms of their buy-sell agreements than they do to funding it. Once the agreement is finalized, the promises in it become legally binding. Adequate funding is key to making sure the buyer has the means to keep those promises. A thoughtful, regularly monitored funding strategy is the key to carrying out the agreement. Without the funds to back it up, a buy-sell agreement can be a bunch of empty promises. Life Insurance Funding. Life insurance may help both the seller and the buyer in an installment purchase buy-sell. In many buy-sell agreements, the seller’s death is a “triggering event” which requires the buyers to purchase the seller’s interest. Because the seller’s death is such a common triggering event, buyers often purchase life insurance policies on
The Association for Advanced Life Underwriting
the seller to cover this risk. In fact, it is not unusual for the agreement to REQUIRE potential buyers to purchase life insurance. Buyers often purchase term life insurance. One reason they do so is to keep the cost for the life insurance coverage to a minimum. Unfortunately, this strategy may not serve them well in the long term. If the event that triggers the buy-sell is something other than the seller’s death (e.g. the seller’s retirement or disability), a term life insurance policy won’t provide any funds to make the payments. That’s because most term life insurance policies only pay benefits when the insured dies. For a lifetime buy-out the buyer will have to use other financial resources to make the installment payments. If, on the other hand, the buyer had purchased cash value life insurance on the seller instead of term insurance, policy cash values could possibly be distributed to help the buyer make the installment payments.* Thus, cash value life insurance has the potential to provide a buyer with buy-out funds regardless of whether the purchase takes place during a seller’s lifetime or at the seller’s death. When the purchase takes place during the seller’s lifetime, a buyer may be tempted to stop paying premiums on the seller’s policy and allow it to lapse. This may be “penny-wise and pound foolish.” A buyer may still benefit from a policy on the seller, even after the agreement is triggered and payments begin. Some reasons a buyer may wish to keep the policy on the seller in force include: 1. The seller may die during the installment payment period; if this happens, the buyer’s obligation to make the promised payments doesn’t end--the remaining payments must still be made. The life insurance death benefit payable at the seller’s death can provide the cash needed to make those payments. 2. The buyer may wish to recover all or 32 Summer 2012 The AALU Quarterly
part of the costs which were incurred to purchase the seller’s interest; life insurance death benefits may help the buyer recover those costs when the seller dies. Life insurance may also benefit the seller. In an installment buy-out the seller has the risk that the buyer may die before making all the promised payments. When this happens, the responsibility to make the remaining payments usually falls to the buyer’s estate. The seller now has a new risk--that the buyer’s estate will not be able to make the remaining payments. The buyer is no longer around to operate the business in a way that generates the needed revenues. The seller may address this risk by having a provision in the buy-sell agreement that requires a buyer to purchase sufficient life insurance coverage on him/herself to pay off the remaining payments if he/she dies before the installment payments have been completed. That death benefit could be assigned to the seller as security for the payments. After the last payment is made, the assignment could be released. In the alternative, the agreement could give the seller the right to purchase coverage on the buyer to the extent of the amount likely to be due. If the seller already owns a policy insuring the buyer, the agreement could give the seller the right to continue that policy until the final installment is paid. Conclusion A workable buy-sell agreement has two primary components: (1) a binding written agreement that contains the terms of the purchase, and (2) adequate funding to allow the buyer(s) to make the required payments. Buy-sell agreements must be backed up by money or else the promises they make are illusory. Installment agreements designed to purchase an owner’s interest create serious risks for the seller. This is especially true if the
buyer is relying on the business to produce the after-tax cash needed to make the payments. It can be dangerous to expect a business to increase its revenues after an important owner has left. Even if everything goes as planned, inflation may cause the seller to experience a significant loss of purchasing power. Identifying the potential risks and planning for them will help both buyers and seller accomplish their respective objectives. Thoughtful use of cash value life insurance in the buy-sell funding can help reduce the risks to both the buyer and the seller. *2 Income tax-free distributions are achieved by withdrawing to the cost basis (premiums paid) then using policy loans. Withdrawals will reduce the policy’s cash value and the policy’s death benefit. Policy loans will reduce the policy’s cash value and may reduce the death benefit. This assumes the policy qualifies as life insurance and does not lapse. Appendix A (See Chart on corresponding page) —Impact of Inflation on Purchasing Power of Installment Payments Joe Smith agrees to sell his interest in ABC, Inc. for $600,000. Fred Brown agrees to pay $100,000 as a down payment and make ten annual $50,000 payments on December 31st of each year. In addition, he will also pay interest annually on the remaining principal balance. The table below computes the pre-tax purchasing power of each $50,000 principal payment at 2%, 3% and 4% annual inflation. It does not consider the taxation of the principal payment or the amount and taxation of the interest payment. It assumes that Mr. Brown makes the payment on time each year.
End of Year
Principal Payment
Adjusted Value 2% Inflation
Adjusted Value
Adjusted Value
3% Inflation
4% Inflation
1
50,000
49,020
48,544
48,077
2
50,000
48,058
47,130
46,228
3
50,000
47,116
45,757
44,450
4
50,000
46,192
44,424
42,740
5
50,000
45,287
43,130
41,096
6
50,000
44,399
41,874
39,516
7
50,000
43,528
40,655
37,996
8
50,000
42,675
39,470
36,535
9
50,000
41,838
38,321
35,129
10
50,000
41,017
37,205
33, 778
Total:
$500,000
Percent Lost Vs. Lump Sum: These materials are not intended to and cannot be used to avoid tax penalties and they were prepared to support the promotion or marketing of the matters addressed in this document. Each taxpayer should seek advice from an independent tax advisor. The ING Life Companies and their agents and representatives do not give tax or legal advice. This information is
$449,130
$426,510
10.2%
14.7%
general in nature and not comprehensive, the applicable laws may change and the strategies suggested may not be suitable for everyone. Clients should seek advice from their tax and legal advisors regarding their individual situation. Life insurance products are issued by ReliaStar Life Insurance Company (Minneapolis, MN), ReliaStar Life Insurance Company of New York (Woodbury, NY) and Security Life of Denver Insurance Company (Denver, CO). Within the
$405,545 18.9%
state of New York, only ReliaStar Life Insurance Company of New York is admitted and its products issued. All are members of the ING family of companies. © 2012 ING North America Insurance Corporation CN0515-2678-0515
ABOUT THE AUTHORS Peter McCarthy is a senior advanced sales consultant for ING U.S. Insurance. He has more than 20 years of experience in advanced marketing and practiced law as an estate planning attorney with a large Minneapolis law firm. He earned his JD degree from the University of Miami (FL) School of Law and an MBA from Rollins College. Peter can be reached at
[email protected].
Maggie Mitchell is vice president of Advanced Sales for ING U.S. Insurance. She has more than 25 years experience in the financial services, tax, legal and insurance industries. Prior to joining ING, she worked as a life insurance consultant for high net-worth individuals and business owners, and practiced law as an estate planning and business attorney. She is prior chairperson of the LIMRA Advanced Sales Committee and has published numerous articles for industry and legal publications. Maggie can be reached at
[email protected].
The Association for Advanced Life Underwriting
34 Spring 2012 2012 The TheAALU AALUQuarterly Quarterly 34 Summer
The AALU and NAILBA Stronger Together By: Dexter Umekubo & Steven J. Finkle
T
he life insurance industry has evolved significantly over the last several years. We face a rapidly changing financial climate along with a dramatic broadening of the regulatory environment. Neither the National Association of Independent Life Brokerage Agencies (NAILBA) nor the AALU has been immune to these changes. NAILBA has historically served the needs of the Brokerage General Agencies and the AALU the larger community of independent agents. It is exciting that the two organizations have found a significant amount of common ground and have begun the process of forging a close relationship. The AALU formed the Brokerage Task Force (BTF) co-chaired by Eleanor Johnson and Gary Bleetstein in an effort to reach out to the brokerage community and bring them into the AALU fold. It has clearly been a roaring success as is evidenced by the dramatic increase in participation in AALU activities and significant increase of NAILBA members joining the AALU and groups like BRAMCO joining the Issues Alliance. NAILBA members have been active on the BTF and several have been active in the advocacy arena. This year for the first time the BTF made a presentation at the AALU 2012 Annual Meeting. Recent NAILBA board member Steve Finkle participated in this panel discussion along with former House Ways and Means Chairman Bill Archer and Eleanor Johnson. Justin Brown of the AALU moderated the panel. It was very well received and is sure to increase the involvement of NAILBA members in the ever important advocacy arena. NAILBA members have been very instrumental in influencing several of “our” companies to get involved with both the BTF and the Issues Alliance. Though nothing is more important than the “feet on the ground” approach that the AALU truly pioneered and dominates, the old cliché that “money is the mother’s milk of
politics” still holds true. NAILBA members have been the proximate cause of several companies joining and/or increasing their financial commitment to the AALU. In addition, NAILBA’s efforts have led several companies to participate in the advocacy process through both direct one on one contact with legislators, and political contributions directly to specific campaigns. The NAILBA PAC has also made a number of contributions to legislators on the AALU Endorsed Candidate list. NAILBA’s leadership has unique perspective on the collaboration of AALU and the Life Brokerage community. The AALU has always been regarded as a premier organization and its members the top of the industry. Because many BGAs no longer do personal production, membership in the AALU was not an option for most NAILBA members until recently. However, NAILBA has long recognized that the AALU has been and continues to be a major legislative voice for the industry; NAILBA members owe a great debt of gratitude to the long and hard work of the AALU. Many NAILBA members are now able to join the AALU through their affiliations with other organizations, through the AALU Issues Alliance program. NAILBA members now routinely participate in AALU Annual Meetings, the Impact Training program, and making Capitol Hill visits – helping to facilitate telling “our story” to our representatives in Congress. These experiences, coupled with the efforts and experience of the NAILBA Government Affairs Committee, give members the resources, training and support to serve as legislative advocates on NAILBA’s and the AALU’s behalf. AALU’s talented staff members have been featured speakers at numerous producer and/or broker-dealer meetings that have been
The Association for Advanced Life Underwriting
hosted by NAILBA members. They have done a tremendous job of enlightening producers about AALU’s efforts on behalf of our industry. They encouraged agents to be more politically aware and explained why activism is needed to protect and preserve the great benefits of the products we sell for the greater good of our clients. The collaboration between the AALU and NAILBA has been great and NAILBA too has been very active in the legislative issues that affect our industry; having more than one voice delivering the consistent message and engaging in the legislative dialogue can only produce positive results. Several of our members are developing
close relationships with specific legislators; for example, Congressman Jeb Hensarling of Texas, currently the Vice Chair of the House Financial Services Committee and head of the House Republican Conference. If the GOP holds the House in the next election he is the odds on favorite to chair that important committee. Congressman Hensarling and his committee will oversee much of the legislation that will affect our industry in the coming years. NAILBA members have hosted fund raisers on his behalf and contributed substantial dollars to his campaign fund as well as that of several other key endorsed candidates. Many AALU members work with a local Brokerage General Agency or
Independent Marketing Organization – many of which are probably NAILBA members. The insurance industry, though specialized in many areas is becoming more inclusive than ever. The relationship that is being forged between our two organizations is vital to the success of both. Our varied associations, working in tandem to collaborate, exchange, and communicate ideas and concerns that affect us all, strengthens our voice during this critical time.
ABOUT THE AUTHOR Dexter Umekubo is the Vice President and Managing Partner of Salina, Kansas-based Producer’s XL. He is also the 2012 Chairman of NAILBA and a member of the AALU.
Steven J. Finkle
is the President of National Brokerage Associates, Inc., a Rockville, Maryland based full service brokerage house. He is a recent past Board member of NAILBA and an active member of the AALU.
NAILBA is the premiere insurance industry organization promoting financial security and consumer choice through the use of independent brokerage distribution. The purpose of NAILBA is to serve as the national association of life, health and annuity insurance distributors.
36 Summer 2012 The AALU Quarterly
Annual Meeting April 29 - May 2, 2012
The Association for Advanced Life Underwriting 37 The Association for Advanced Life Underwriting
Thank you to the to 2012 Thank you the 2012 Annual Meeting Exhibitors
Annual Meeting Exhibitors
ALIRT Insurance Research, LLC
MassMutual Financial Group
American General Life Companies
MetLife
Apex Underwriting Solutions, a Concierge Underwriting
Million Dollar Round Table
Service
Minnesota Life Insurance Company
Ash Brokerage
NAIFA
Ashar Group LLC - Life Settlement Specialists
National Underwriter Company
AVIVA USA
Nationwide Financial
AXA Equitable
New York Life Advanced Markets Network
Capitas Financial
Newport Group
Crump Life Insurance Services
PartnersFinancial
Disability Insurance Services
Principal Financial Group
Ebixlife
Pro Financial Services
Elite Producer Group (AXA Equitable)
Pro Micro, Inc.
Exceptional Risk Advisors, LLC
Prudential
First Financial Resources
Saul Ewing LLP
First Heartland Corporation
Society of FSP
First Insurance Funding Corporation, Inc.
Summit Business Media
Forum 400
The American College
Gentry Partners, Ltd. / Ogilvie Sercurity Advisors Corp
The Guardian Life Insurance Services Company of
Genworth Financial
America
Herman Agency, Inc.
The Hartford
Highland Capital Brokerage, An NFP Company
The Lifeline Program
ING
The Penn Mutual Life Insurance Company
InsMark, Inc
The Widsom Link
Insurance Media Services
TomHegan.com
Insurance News.Net
Total Financial and Insurance Services Inc.
John Hancock Life Insurance
Transamerica Life Insurance Company
LIFE Foundation
Wells Fargo Private Bank
Lincoln Financial Group 38 Summer 2012 The AALU Quarterly
Thank you to the 2012 Annual Meeting Sponsors Diamond
Platinum
Gold
SUMMIT BUSINESS MEDIA Life & Health Insurance Group
P R O V E N L E A D E R S I N T H E L I F E & H E A LT H I N S U R A N C E I N D U S T R I E S S I N C E 1 8 9 7
Silver
Bronze
The Association for Advanced Life Underwriting
The AALU 2012 Annual Meeting - By The Numbers
1. Why don’t we move the Annual Meeting to another hotel? 2. Will CE return in 2013? 3. Will registration prices increase for the 2013 Annual Meeting? 4. Why don’t we have members of Congress speak from the Main Stage? 5. Who will be the “Big Name” on the Main Stage in 2013? 40 Spring 2012 The AALU Quarterly 40 Summer 2012 The AALU Quarterly
FAQs
2012 Annual Meeting meeting attendees used their survey responses to submit questions. Here are the Top Five most Frequently Asked Questions. It’s true that we have outgrown the Marriott Wardman Park. We are looking at a number of alternatives, but before we can move the meeting, we have to fulfill our contract that runs through 2016. Currently, there is only one other hotel in the Washington area that can accommodate a group our size and it’s not in the District of Columbia – the Gaylord National Hotel in National Harbor, Maryland.
1.
It’s a secret for now, but rest assured the Program Planning Committee is hard at work creating an Annual Meeting experience that will continue the tradition of the AALU Annual Meeting being THE destination meeting in the Life Insurance markets.
5.
Never say never, but it’s unlikely the Annual Meeting workshops will qualify for CE in 2013. We discontinued CE credits when the per credit cost of the credits requested from attendees reached $300+ per hour. Fewer than five AALU Members requested we keep CE as part of the Annual Meeting. What there will be more of at the 2013 meeting is learning opportunities on the AALUniversity Learning Stage, the AALUniversity Workshops and on the Main Stage in special AALUniversity sessions.
2.
3.
No! There will be no price increases for Annual Meeting registration for AALU Members. And, there will be new incentives for members to register and renew their membership at the same time.
The short answer is scheduling. Congressional leaders can’t commit to a public appearance off Capitol Hill more than a day or two in advance. And even then, the rescheduling rate is near 100%. That makes it impractical to include live remarks from a sitting lawmaker during a Main Stage session.
4.
The Association for Advanced Life Underwriting 41 The Association for Advanced Life Underwriting
Annual Meeting Facts
62
1386
95
Top Ten States for Attendees
All time high registration
50 32 47 32
83
42 Spring 2012 The AALU Quarterly 42 Summer 2012 The AALU Quarterly
70
45
Top Reasons for Registering for the Annual Meeting
26%
Main Stage Speakers
25% 19%
What’s Happening in Congress Get more Engaged in the AALU
16%
Networking with Peers
Favorite Main Stage Speakers President William J. Clinton Carly Fiorina Dr. Michio Kaku
#1
#3 #2
#3
41% Prospects converted to members
The Association for Advanced Life Underwriting 43 The Association for Advanced Life Underwriting
Washington Report Index The trusted source of actionable technical and marketplace knowledge for AALU members—the nation’s most advanced life insurance professionals.
The AALU Washington Report is published by AALUniversity, a knowledge service of the AALU. The trusted source of actionable technical and marketplace knowledge for AALU members—the nation’s most advanced life insurance professionals. The AALU Washington Report is prepared by the AALU staff and Greenberg Traurig, one of the nation’s leading law firms in tax and wealth management. For more information about the AALU or this report, please visit www.aalu.org. Counsel Emeritus Gerald H. Sherman 1932-2012 Stuart Lewis 1945-2012
At the 2012 Annual Meeting we launched the new Washington Report. Here is an index and synopsis of the Washington Reports published since. To read the full reports, please visit AALU.org. Washington Report 12-22 TOPIC: Proposal to Tax Grantor Trusts Could Impact Life Insurance Planning. SYNOPSIS: The President’s proposed federal budget for fiscal year 2013 includes a proposal to coordinate the income and transfer taxation of “grantor trusts” so that estate and gift taxes
are imposed on a trust based solely on grantor trust status (the “proposal”). The proposal is a significant departure from current law, which taxes the assets of a grantor trust as if they are still owned by the trust grantor for income tax purposes but not for transfer tax purposes.
Washington Report 12-23 TOPIC: Tax Court Denies Deductions for Contributions to Life Insurance-Funded 419 Plan but Rejects IRS Position on Constructive Receipt of Accumulated Policy Value.
SYNOPSIS: In a recent case, the Tax Court disallowed deductions claimed by a taxpayer’s
wholly-owned corporation for contributions made on behalf of him and his family members to
a 419 plan and required the taxpayer to include the amount of those contributions in his gross income. The Tax Court found that the plan was merely a vehicle to facilitate the taxpayer’s personal investment in life insurance.
101 Constitution Ave. NW Suite 703 East Washington, DC 20001 Toll Free: 1.888.275.0092 Fax: 202.742.4479 www.aalu.org
Washington Report 12-24 TOPIC: Employer-Owned Life Insurance (“EOLI”) - Tax Traps for the Unwary SYNOPSIS: To make sure that businesses use life insurance responsibly, , the Pension
Protection Act of 2006 enacted Internal Revenue Code (“IRC”) §101(j), which taxes death
benefits paid to owners of EOLI contracts if requirements set forth in the legislation are not
met. Tax can be avoided in most situations if certain notice and consent (“N&C”) requirements are met prior to contract issuance. As illustrated by a recently released private letter ruling,
however, advisors may overlook these requirements if they fail to realize that many common business and estate planning arrangements will involve EOLI contracts. Unfortunately,
corrective actions are limited and may require cancellation of an existing policy and satisfaction of the N&C requirements before re-issuance. 44 Summer 2012 The AALU Quarterly
Washington Report Index Washington Report 12-25 TOPIC: More Economic and Cost-Benefit Analysis to be Required in SEC Rulemakings SYNOPSIS: The Securities and Exchange Commission (“SEC” or “Commission”) has been widely criticized in recent
years for the promulgation of rules lacking an empirical justification and/or a proper examination of potential economic
impacts, costs, and benefits. This criticism intensified after the enactment of the Dodd-Frank Act (“Dodd-Frank”), which tasked the SEC with more than one hundred new rulemaking projects.
Now, recent developments such as (a) successful legal challenges against SEC rules; (b) criticism of economic analysis
in SEC rulemakings by the Government Accountability Office (“GAO”) and the SEC’s Office of Inspector General (“OIG”); and (c) bipartisan congressional criticism regarding several SEC regulatory projects have led to the issuance of new rulemaking guidance by the SEC’s Office of General Counsel (“OGC”) and Division of Risk, Strategy, and Financial Innovation (“Risk Fin”). Under these new standards, SEC rulemaking teams must clearly identify the need for new
regulation; measure projected economic impacts against a quantifiable baseline; balance the costs and benefits of issuing a particular rule; and consider regulatory alternatives—including the option of taking no regulatory action.
Washington Report 12-26 TOPIC: Final Retirement Plan Fee Disclosure Regulations under ERISA Section 408(b)(2) SYNOPSIS: The DOL has issued final retirement plan fee disclosure regulations requiring that covered service providers
satisfy certain disclosure requirements by no later than July 1, 2012 in order to qualify for the statutory exemption from the prohibited transaction rules for services under ERISA section 408(b)(2).
Washington Report 12-27 TOPIC: IRS Allows 20% Escalating Annuity Payments in a Testamentary Charitable Lead Annuity Trust (“CLAT”) SYNOPSIS: The ability of a CLAT to backload annuity payments to a charity may increase both the total charitable
distributions and the amounts passing to the CLAT remainder beneficiaries. Prior IRS guidance has indicated that CLATs can provide for escalating annuity payments but has failed to provide specific insight into the extent to which such
payments may be backloaded. In PLR 201216045, however, the IRS approved of an annuity formula that would allow a testamentary CLAT to make increase the annuity payments by 20% each year.
The Association for Advanced Life Underwriting
LIFE INSURANCE
ADVANTAGE: AN IUL YOU CAN FEEL GOOD ABOUT SELLING. Here’s why PruLife® Index Advantage UL (Advantage UL) is the permanent policy you can feel good recommending. STRAIGHTFORWARD, TRANSPARENT DESIGN Clients have the opportunity to build potential cash value with two interest-bearing accounts: the Indexed Account, based on the performance of the S&P 500®, which excludes dividends; and the Basic Interest Account, with fixed interest guaranteed to be at least 2%. RESPONSIBLE APPROACH TO ILLUSTRATED RATES Our 25-year look-back* helps to set expectations of potential performance and premiums. STRONG UNDERWRITING AND SERVICE Superior underwriting for tough cases. Age Last Birthday pricing. And 22-day average from application receipt to case approval.** To learn more, contact your Brokerage General Agency or visit prudential.com/AdvantageUL
PruLife Index Advantage UL is issued by Pruco Life Insurance Company in all states except in New York where, if available, it is issued by Pruco Life Insurance Company of New Jersey. Both are Prudential Financial companies located in Newark, NJ and are solely responsible for their own financial condition and contractual obligations. All guarantees are based on the claims-paying ability of the issuer. The potential for cash value accumulation in the indexed account is based on the performance of the S&P 500® Index, which excludes dividends on a yearly point-to-point basis up to the Index Growth Cap (“the cap”). Money that is placed in the Indexed Account is not a direct investment in the S&P 500® Index. The cap is generally stated as a percentage, which is the maximum rate of interest that will be credited at the end of the one-year Index Segment Duration, regardless of performance of the index over the cap. The cap is declared for each Index Segment in advance of each Index Segment Duration. The cap is subject to change at our discretion, both up and down, but is guaranteed to never be less than 3.00%. Changes to the cap could result in different policy performance and/or different values than shown here. Changes to the cap are not tied to the performance of the underlying index and may be based on interest rates, market volatility, and other factors. Caps and Floors may be different in selected states. “Standard & Poor’s®”, “S&P®”, “S&P 500®”, and “Standard & Poor’s 500™” are trademarks of Standard & Poor’s and have been licensed for use by The Prudential Insurance Company of America for itself and affiliates. This indexed product is not sponsored, endorsed, sold or promoted by Standard & Poor’s and Standard & Poor’s makes no representations regarding the advisability of purchasing an indexed policy. S&P 500® index values are exclusive of dividends. * Past performance does not guarantee future results. **22-day average based on our current portfolio and does not take Advantage UL into account. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide. © 2012 Prudential Financial, Inc. and its related entities. FOR FINANCIAL PROFESSIONAL USE ONLY. NOT FOR CONSUMER USE. 0225178-00001-00
46 Summer 2012 The AALU Quarterly
Washington Report Index Washington Report 12-28 TOPIC: Fiduciary Considerations in Administering Irrevocable Life Insurance Trusts (“ILITs”). SYNOPSIS: Several recent cases targeting ILIT trustees illustrate that ILITs present unique fiduciary challenges in terms
of administration and asset management. The growing complexity of life insurance products, along with the administrative requirements to preserve an ILIT’s intended tax benefits, can make ILIT trust administration far more complicated than anticipated, particularly for non-professional trustees.
1 AG
6/12/12
Washington Report 12-29
Job No:
CLTR-A4180 Job Name:
IAULTOPIC: PAGE AD Final Retirement Plan Participant Level Fee Disclosure Regulations under ERISA Sections 404(a) and Pub:
404(c).
AALU SUMMER Date:
7/16/12
Live: SYNOPSIS:
8 x 9.875 that Trim:
8.5 xthe 11 Bleed:
The DOL has issued final retirement plan fee disclosure regulations for individual account plans requiring
plan administrators comply with certain disclosure requirements by no later than August 30, 2012 in order to satisfy
general fiduciary requirements under ERISA Section 404.
8.75 x 11.25
Washington Report 12-30
CLIENT
______________
TOPIC: Issuance of Temporary Portability Regulations - Practical Take-Aways.
ACCOUNT
______________ WRITING
SYNOPSIS: The IRS has just released long-awaited temporary regulations that provide guidance on how a decedent’s
______________
estate can elect to provide the decedent’s remaining estate tax exclusion to his or her surviving spouse. While these
DESIGN
regulations clarify and in some cases simplify the process for electing portability, they still present challenges, particularly
______________ CREATIVE
for smaller estates that generally would not be required to file estate tax returns.
______________ PRODUCTION ______________
Washington Report 12-31
PROOFREADING
______________
TOPIC: U.S. Supreme Court Upholds the Individual Mandate and Medicaid expansion provisions of the Health
Prepared by Prudential Advertising, Care Reform Legislation, Allowing Implementation of New Tax Provisions 213 Washington St Newark NJ, (973) 802-7361 SYNOPSIS: The constitutionality of the ACA (specifically, the individual mandate Fax (973) 367-6173
and the Medicaid expansion provisions)
was challenged as an invalid exercise of congressional powers. The Supreme Court largely upheld the constitutionality ■ ■■ ■■ DO■ NOT PRINT of the ACA, concluding that (1) the individual mandate was a valid exercise of Congress’ taxing powers (but not a valid exercise of its authority to regulate interstate commerce under the Commerce Clause or the Necessary and Proper T:11 in
B:11.25 in
S:9.875 in
Clause) and (2) the ACA’s expansion of Medicaid to nearly all Americans under age 65 with incomes of up to 133% of
the federal poverty level was constitutional (but the penalty imposed on states that fail to expand coverage was not). The Supreme Court’s decision left the other provisions of the ACA intact, including a number of tax and tax-like provisions covering a wide spectrum of persons and entities.
The Association for Advanced Life Underwriting
Washington Report Index Washington Report 12-32 TOPIC: Proposed Regulations under Code §83, Property Transfers for Services SYNOPSIS: Treasury and the IRS recently released proposed regulations under Internal Revenue Code §83 (the
“proposed regulations”), supposedly to clarify the timing of taxation for transfers of property subject to a risk of forfeiture by noting that for purposes of Section 83 (i) a substantial risk of forfeiture (“SRF”) can only be established through a service
condition or a condition related to the purpose of the property transfer, (ii) both the likelihood that a forfeiture will occur and the likelihood that it will be enforced must be considered in determining whether a SRF exists, and (iii) transfer restrictions
other than a restriction under section 16(b) of the Securities and Exchange Act of 1934 (the “Exchange Act”) do not create a SRF.
Washington Report 12-33 TOPIC: Potential IRS Review of Certain Private Split Dollar Arrangements SYNOPSIS: Based on recent reported comments, the IRS may be undertaking a national review of certain private SDAs, including consideration of whether Code §2702 should apply to these particular transactions. Application of that Code
section could result in gift tax exposure to clients for the full amount of premium payments they make on policies subject
to private SDAs. While the scope and details of the purported review are not know, the catalyst for this review may be an IRS interest in so-called “generational” SDAs, which potentially increase the leveraged wealth transfer benefits of private split-dollar plans.
Washington Report 12-34 TOPIC: Planning with Hard-to-Value Assets: Limiting Gift Tax Exposure with Defined Value Clauses SYNOPSIS: Clients may face gift tax exposure when gifting or selling hard-to-value assets if the IRS argues that the
appraised value is too low. Defined value clauses may address this issue by limiting the gift to a fixed dollar amount, so
that a subsequent valuation adjustment to the gifted asset does not affect the value of the taxable gift. While the IRS has consistently challenged defined value clauses, several court decisions have upheld their use, including the recent case
of Wandry v. Commissioner. In Wandry, the taxpayers made gifts of units in a family business to their descendants based on a formula transfer clause. The IRS challenged both the valuation of the units and the use of the clause, arguing that
the taxpayers actually made gifts of a fixed percentage interest in the business in excess of their gift tax exemptions and annual exclusion amounts. The Tax Court disagreed, finding that the taxpayers’ gifts were fixed by the formula, and that the IRS’s valuation adjustment resulted only in a correction of the allocation of business units among the taxpayers and the donees, not in additional taxable gifts. 48 Summer 2012 The AALU Quarterly
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The Inflation Protection Rider is optional and available at an additional cost when the rider is exercised. The cost of the rider is based on age, gender, death benefit amount, and risk class. Guarantees are backed by the financial strength and claims-paying ability of Allianz Life Insurance of North America. Annuity Specs, Indexed Sales and Market Report, Q1 2012, www.annuityspecs.com. Annual floor is guaranteed on an annual basis and will never be less than 1%. 3 Policy loans and withdrawals will reduce the available cash value and death benefit and may cause the policy to lapse, or affect guarantees against lapse. Additional premium payments may be required to keep the policy in force. In the event of a lapse, outstanding policy loans in excess of unrecovered cost basis will be subject to ordinary income tax. Tax laws are subject to change and your clients should consult a tax professional. Life insurance involves certain fees and expenses that should be discussed with your clients. It also requires health, and in some cases financial, underwriting. Products are issued by Allianz Life Insurance Company of North America, 5701 Golden Hills Drive, Minneapolis, MN 55416-1297. 800.950.7372 www.allianzlife.com Product and feature availability may vary by state. P54350 MLIF-1080 (9/2012) The Association for Advanced Life Underwriting 1 2
50 Spring 2012 The AALU Quarterly 50 Summer 2012 The AALU Quarterly
The 2012 Gerald H. Sherman Award Recipent David Downey The 2012 Gerald H. Sherman Award, created in 2005 to honor those members of the AALU whose service has contributed to the life insurance profession, has been awarded to AALU Past President David Downey.
“When Congress last considered comprehensive tax reform 26 years ago, Dave Downey was sitting at the witness table before the House Ways and Means Committee defending our clients and profession from attack.
Since 2005 the Past President’s Committee has selected an individual who represents the best of our association and profession. Named for the award’s first recipient, the Jerry Sherman Award is more than a lifetime achievement award. It is recognition by peers that a Member has gone above and beyond the call of duty to help the AALU fulfill its mission of promoting, protecting and preserving life insurance.
He co-chaired an AALU task force that helped the industry defer changes to tax rules governing split-dollar arrangements and grandfathered existing arrangements. And if you’ve ever wondered how the AALU ever came to be in favor of permanent, sustainable estate tax reform so clients can plan with certainty, it’s because Dave Downey chaired the original task force that set the foundations for that position.
Downey served as the AALU’s president in 1984 and is one of only a handful of people who has qualified for Top of the Table every year since the designation was created.
Let me add something you may not know - Dave Downey still owns the alltime single game scoring record for the University of Illinois basketball team. He scored 53 points against Indiana in February 1963 - a record that stands to this day.
Downey is a lawyer, a CLU since 1966, and a tireless advocate for the life insurance profession in the marketplace and on Capitol Hill. In presenting the Award, past President Bud Schiff recounted Downey’s many accomplishments:
On behalf of your fellow AALU Members, thank you for all that you have done, and continue to do, for this profession and the clients that rely on us.”
The Association for Advanced Life Underwriting
52 Spring 2012 The AALU Quarterly 52 Summer 2012 The AALU Quarterly
The Importance of a Unified Message
T
here is no shortage of serious challenges ahead for the life insurance industry. This year presents us all with the rare confluence of trillions of dollars in expiring tax relief, spending cuts, and new taxes on earned and investment income—most of which will come to fruition on the same day (Jan. 1, 2013) without congressional action. This dynamic is laid against the backdrop of an economy and labor market that are struggling to reach requisite growth targets. There’s also the matter of electing a President and determining which party will control the agenda in Congress. This environment presents a number of challenges for the industry—particularly in the next six to eighteen months, when decisions on expiring taxes will be made and strategies for long-term reform initiatives will be put in place. The
collective scope of these challenges is so great that virtually every household, business, and industry is a stakeholder. Accordingly, there are a number of competing interests in play—which places a premium on the delivery of a persuasive, well-supported, and consistent message. This is where AALU members and producers across the industry can distinguish themselves from other stakeholders in this marketplace for the attention and support of Members of Congress. Inconsistent messaging creates a fractured industry, which confuses lawmakers and undermines the strong arguments that this industry has to make regarding the protection and promotion of its products. The AALU Advocacy Notecard is designed to avoid this potential pitfall – namely, to speak with one voice when The Association for Advanced Life Underwriting
citing the economic value provided by the industry and its products and when articulating the legal and public policy arguments for protecting the tax treatment of life insurance, enacting permanent estate tax reform, and demanding reasonable and properly justified regulatory requirements for producers. The data and arguments on the Notecard are the byproduct of months of deliberation amongst the AALU staff, counsel, Board of Directors, volunteers, and our industry partners. The goal of the Notecard is to provide our members with a tool to facilitate their delivery of concise, repeatable arguments that will gain traction with Members of Congress and their staffs. AALU members have a compelling story to tell their elected officials, for example: •
Permanent life insurance is a reliable product that provides protection and can also provide a guaranteed, predictable rate of return that is more stable than the returns offered by
54 Spring 2012 The AALU Quarterly 54 Summer 2012 The AALU Quarterly
numbers reflect the fact that the industry represents a dependable private sector source of benefits and long-term retirement savings. Few industries can match the life insurance industry’s impact on both the macro-economy and local community economies across the nation.
pure investment vehicles. Purchased with after-tax dollars, permanent life insurance also provides vital benefits to beneficiaries after the premature loss of a primary income earner to take care of immediate and future needs of family members. •
•
Not only do families depend on life insurance for protection in the event of an unexpected loss of a loved one, but businesses purchase permanent life insurance, commonly known as corporate-owned life insurance (COLI), to make payroll and protect jobs after the death of owners or key employees. Another important use is to finance and make sure employers deliver on the critical employee benefits they promise, including health, disability, survivor and supplemental retirement benefits. The data on the Notecard speaks volumes about the breadth and versatility of the industry. These
•
Aside from the unmistakable public policy benefits provided by life insurance products, there is also a sound tax policy argument to be made for the preservation of the tax treatment of the product, as the current treatment is consistent with historic tax policy norms. Specifically, appreciation of taxpayer assets is not taxed until a realization event occurs and proceeds become available to pay the tax. For example, appreciation in the value of a stock or a home is not taxed until those assets are sold. Similarly, the above mentioned “cash value” within a permanent life insurance policy is
not taxed until the policy is sold or surrendered. Furthermore, when a recognition event does occur, any realized gains are taxed as ordinary income, not at lower, preferential rates. Similarly, as the vast majority of our members are engaged in estate or business succession planning for families and businesses alike, our Notecard conveys simple, practical arguments that support our call for permanent estate and gift tax reform that includes unified lifetime exemptions: •
Permanent estate and gift tax reform is needed to establish a framework that can be relied upon for planning purposes when families and businesses are considering their options over 30, 40, and 50 year windows. If families and business owners are unsure of the estate tax exemption level, rates, and underlying technical framework, they are less likely to engage in estate and business succession planning, which leads to unsuccessful transfers to succeeding generations and problems for the family members, employees, and businesses left behind.
•
Moreover, the unification of estate and gift tax lifetime exclusions is a common sense reform that was re-enacted in 2010 after several years of disjoined exemptions--a result of AALU member advocacy. The decoupling of these exemptions created a perverse incentive for business owners to retain their assets until death rather than making responsible intergenerational transfers during life—an action that greatly increases stability in business succession. Unified estate and gift tax credits allow for earlier transfers, which in the business succession context creates incentives for the next generation to participate in the management and development of the business, providing successors with important experience and a more significant financial interest in the success of the business.
for you to experience Capitol Hill Club without traveling to Washington. Dozens of AALU members have led meetings with their elected officials in their home states and districts this summer—and the congressional schedule ahead presents several excellent opportunities to connect with lawmakers at home, beginning with the five-week August recess. Remember, you can’t delegate personal engagement—and our path to advocacy success and the protection of your business is to maximize the level of personal engagement across the entire AALU membership. With so much at stake, and critical decisions looming in Congress, none of us can afford to sit on the sidelines. The AALU can unlock its true potential and best protect our members interests when each of our members is personally engaged and speaking with one collective voice.
It can seem challenging to deliver these often complicated public policy arguments to Members of Congress—but this is where our Notecard can be helpful and we urge you to use it and use it often. For example, you may have seen notices of our “CHC InDistrict” program in your inbox throughout the summer. CHC In-District is a way
Questions? About the AALU Advocacy Notecard or the AALU’s policy positions? Contact Anthony Raglani at 202-742-4589 or at
[email protected]. About scheduling and/or leading a CHC In-District meeting? Contact Brendan Gleason at 202-742-4631 or at
[email protected].
The Association for Advanced Life Underwriting
Why the Insurance Industry Has a Monopoly on Retirement By: Tom Hegna CLU, ChFC, CASL
T
hanks to the unpredictable nature of today’s financial markets, many boomers are unsure if they are going to be able to afford the same quality of a retirement that had once been available. Some are even worried that they won’t be able to retire at all! I’m here to tell you that there is hope. “Happily Ever After” still exists, and our industry, our products, and the simple solutions we offer are exactly what boomers and seniors need to achieve their storybook retirement. There is no sense in hiding the facts; there is more uncertainty surrounding retirement than ever before. With the decline of Social Security and company pensions, most boomers are left with just their personal savings to fund the bulk of their retirement. In addition, boomers and seniors are faced with numerous potential detriments to their retirement, such as longevity risk, deflation risk, market risk, 56 Summer 2012 The AALU Quarterly
mortality risk, inflation risk, withdrawal rate risk, order of returns risk, and longterm care risk. Every one of these risks has the potential to devastate a boomer’s savings. However, of all the risks mentioned, longevity risk is hands-down the most dangerous. Over time, with improved medical technologies and health awareness, people have been living longer and longer. About 100 years ago, the average life expectancy was only 50 years old. Now, if you take a husband and wife who are 65, there is a 50/50 chance that one of them will live to age 92. There is a 25 percent chance that one of them will live to 97. This is great news for everyone, but it also presents some big retirement hurdles. Longevity risk is actually a risk multiplier for all the other risks because the longer a person lives, the more likely they are
to be affected by the other risks. In other words, if people knew they were going to die tomorrow, it wouldn’t matter if the stock market crashed 1,000 points next week because it wouldn’t impact them. They would already be dead. However, what if your clients live to the ripe old age of 100 or older? They would have a much greater risk of being impacted by all the other risks! And considering that centenarians are now the fastest growing age segment in the United States, this is the reality they must plan for! They must take longevity risk off the table. The optimal way to eliminate longevity risk is to purchase a lifetime income annuity or deferred lifetime income annuity. Those are the best ways due to the mortality credits a client receives. The more popular options of a variable annuity with lifetime income guarantees or an index annuity with lifetime income guarantees can also work, although they will not pay the
same level of mortality credits. But that’s it. Other options, such as stocks, money managers, hedge funds, and bonds can not eliminate longevity risk. The lifetime income and deferred lifetime income annuities will guarantee the policy holders a consistent known income, which is the key to generating the funds to cover basic retirement expenses in today’s unpredictable economy. For those who would still like to participate in the
market, the variable annuity with a lifetime income guarantee is a great alternative. These investments are very easy for clients to understand and can be related to how Social Security payouts work. In exchange for a one-time upfront payment, they receive a guaranteed monthly paycheck for the rest of their life. For example, if a 65 year old man put $100,000 in to
a lifetime annuity, he would receive a monthly check for approximately $550, which is over a 6 percent payout rate. The reason this rate is so attractive is because in addition to receiving a portion of his original principle plus interest, he also receives mortality credits from policy holders who die early. As people live longer, mortality tables are adjusted, so it’s important to remind clients that the The Association for Advanced Life Underwriting
mortality rates today are likely to be the best an annuity purchaser will ever see. Most people purchase an annuity with a single premium when they are in retirement. Since only a portion of their wealth is used to purchase the annuity, the rest of the money is optimized with inflation in mind. Consequently, clients should consider moving some of the portfolio to inflation-sensitive investments, such as commodities, energy, and real estate. If inflation comes and interest rates begin to rise, the client’s portfolio should rise as well, they can then purchase additional income annuities to help them ladder their income in retirement. Younger clients can purchase a deferred income annuity. Most of these policies are flexible premium type policies where they can add money over time. In a low interest rate environment, some clients may be wondering whether or not to wait for a higher interest credit rate before they invest. In reality, we could stay in this very low interest rate environment for decades. Japan has been in a zero interest rate environment for over 25 years. With budgets at the local, state, and federal levels facing debts never seen in the history of our country, deleveraging in the private sector as well, housing still a mess, unemployment numbers we haven’t seen since the great depression, and the fact that baby boomers are past their peak earning and spending years, we are facing massive deflationary pressures. The government has printed a lot of money in the last few years, but there is no money velocity. That being said, clients should not try and time their investment based on market conditions – an income annuity should be purchased when the client needs income. Again, only a portion of the client’s money is used and they can purchase additional income annuities in the future, should they need additional income. Also, since each check from a lifetime income annuity is composed of three parts – principal, 58 Summer 2012 The AALU Quarterly
interest, and mortality credits – interest is only a portion of the check and it comprises a smaller and smaller piece of the payout as the person ages. Lastly, clients also need to understand why life insurance companies are able to offer these amazing retirement solutions. By offering life insurance and annuity products, life insurance companies can protect themselves by being on both sides of the risk. The risk to the insurance company when someone buys a lifetime income annuity is that they live too long. The risk to the insurance company when someone buys life insurance is that they die too soon. If people live longer, they will have to pay more lifetime income annuity payments but won’t be paying as many death claims. If an epidemic wipes out a portion of the population, they will be paying death claims but not lifetime income payments. By being on both side of the risk equation, they can neutralize the risk to themselves and offer incredible products that no one else can. Remember, no matter how unpredictable today’s financial markets become, boomers and seniors will always be able to find the solutions they need and want from life insurance companies. Armed with simple products that guarantee that they’ll never run out of money, “Happily Ever After” still exists! Now go out there and show them why the insurance industry was BUILT for markets like these.
ABOUT THE AUTHOR
Tom Hegna CLU, ChFC, CASL is a retirement expert, speaker, and author of the bestselling book Paychecks and Playchecks: Retirement Solutions For Life. As a former First Vice President for New York Life, he has delivered over 2,000 seminars on retirement. Tom’s words have literally had a multi-billion dollar impact on the industry. To book Tom as a speaker or learn more, visit www.TomHegna.com
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A Special Thank You to those PAC leaders that have given at least $1,000 to the AALU PAC so far in 2012!
The Association for Advanced Life Underwriting
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legislative circle program Congratulations and a special thank you to those AALU members who have already qualified in 2012!
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The Association for Advanced Life Underwriting
legislative circle program
legislative circle program Michael Lyman (17) David Malone (18) Carl Mammel (25) Paul Mass (3) Bruce McGuirk (15) Patrick McNamara (22) Anthony Mento (1) Antonio Moreno (7) Eric Naison-Phillips (3) Lawton Nease (25) Thomas Olexa (2) Gregory Olsen (1) Shirley O’Neil (3) Michael Padon (25) Ralph Pence (1) Anthony Perricelli (22) Matthew Phillips (8) Lisa Powell (8) Robert Powell (16) Reginald Rabjohns (18) Mark Rooney (6) Michael Rosenzweig (24) Lawrence Rybka (20) David Scott (5) Thomas Sellin (7) Dean Steliotes (3) Roger Sutton (23) Richard Tanner (4) Matthew Tassey (9) Hardy Vaughn (25) Mark Weber (21) Lawrence Wiener (9) Dennis Zahrbock (19) Leslie Zuckerman (2)
PATRIOT Delynn Alexander (2) Dennis Amico (11) Marla Aspinwall (10) Odon Bacque (11) Jeffrey Barker (3) Brodie Barnes (4) Bradley Baune (1) Jeffrey Bear (4) Paul Berlin (15) J. Boyd Bert (17) Robert Black (2) Gary Bleetstein (2) William Borchert (3) Scott Brennan (10)
62 Summer 2012 The AALU Quarterly
Deanna Brooks (8) Royall Brown (7) Stephen Burk (4) Mark Byron (23) Scott Cahill (10) Christopher Cairns (2) Caleb Callahan (2) Roger Cammon (3) Joshua Cobb (4) Jay Courtney (3) Joseph Crea (14) Donald Curristan (11) Andrew Dalgliesh (4) James Dargusch (2) William Dodd (20) Lyle Domenitz (3) David Downey (25) Michael Dranoff (6) William Ebel (5) Dennis Eckels (2) Robert Eddy (1) Robert Eichler (4) John Ertz (4) Michael Fanning (1) Karl Feitelberg (5) Charles Feldman (13) Michael Ferik (3) Tracy Fitzsimmons (1) Herb Foedisch (4) Larry Fortenberry (13) James Foyt (6) Brian Friedman (8) William Gearhart (4) Julius Giarmarco (10) Ronald Greenberg (4) George Groome (8) Joseph Guyton (2) Carrie Hall (3) Douglas Hammond (3) Todd Healy (23) James Hecker (2) Rodger Hergenrader (8) Ronald Hilliard (12) David Hoff (10) Jeffrey Holler (9) Patrick Horne (1) David Howell (9) James Huckabee (1) Dave Hunter (16) Louis Hyman (5)
Joseph Ivcevich (9) Gregory Jensen (1) Susan Jossi (7) Terry Kaltenbach (13) Allan Kaplan (22) Barton Kaufman (23) Sean Kelly (3) Kurtis Kidder (11) Kenneth Knox (1) Dean Kohmann (2) Steven Kosnick (1) Arthur Kraus (9) Tod Lashway (1) Carolyn Lloyd-Cohen (10) David Loew (12) Roger Lowery (16) James Magner (3) John Marshall (17) Kenneth Masters (1) Michael McNeil (2) John McSwaney (25) Donald Mehlig (25) James Mellin (10) Alan Meltzer (16) Jason Mendelsohn (1) Todd Mezrah (15) Gwen Middeke (15) Gregory Mitchell (1) James Monteverde (19) David Morris (6) Connie Morrison (17) James Morrison (8) Adrienne Mouch (6) Daniel Mulheran (5) John Mulheran (6) Dennis Mullen (3) Carlos Musibay (1) Chad Neifer (6) Bayne Northern (2) Peter Novak (3) Randy O’Connor (6) Deborah O’Neil (13) Wayne Pangburn (11) Norman Pappas (21) Carl Peterson (1) Phillip Pickett (5) Jay Pollack (5) William Pollak (4) Charles Provow (6) Gregory Raabe (13)
Todd Reid (2) George Ridings (1) Sanford Robbins (13) Alfred Robertson (2) Richard Romano (4) Brett Rosen (14) Curt Rynties (4) William Sapers (20) Philip Sarnecki (3) Gabriel Schiminovich (8) Randy Schuster (2) Brad Seitzinger (4) Joel Shapiro (24) Craig Shigeno (3) Mark Siegman (4) Ellen Singer (3) Tim Sinks (3) Lee Slavutin (16) Richard St. Jean (2) Walter Stern (17) Maurice Stewart (2) Nebojas Subotic (3) Robert Swartzbaugh (25) David Taylor (8) Donald Taylor (2) Gray Teekell (18) Mark Teitelbaum (5) Henry Thomas (2) Richard Thomas (2) Barbara Tomeo (11) Raymond Triplett (10) Walter Van Buren (13) Paul Vignone (3) Eamon Walsh (2) Thomas Waring (4) David Watros (7) David Wexler (4) William Whitaker (14) David Wilken (7) Kirk Wimberly (13) John Zimdars (11)
