IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities.  Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family businesses. The following content has been provided by Marc Bannos. Mr. Bannos is a Registered Investment Advisor with Equilus Group, Inc. (www.equiluscapital.com), an independent registered advisory firm. He entered the financial services industry in 2015 and worked for several large wirehouse firms and big banks prior to entering the independent world. Including 1031 alternatives & personal financial planning services, he specializes in the administration of business retirement plans, estate & succession planning.

Life Insurance: Important Safety Net or Unnecessary Expense for an Entrepreneur

Insanity?  Inappropriate?  These are words that I’ve heard from peers and clients alike on this mysterious word, but they don’t describe the “I” in question.  Today, I’m going to delve into a subject that many people in my industry (and clients alike) don’t like to discuss- Insurance!  As a financial planner, I personally find it disingenuous and unprofessional when I hear my fellow planners belittle the importance of life insurance/LTC when we talk about the planning process, but at the same time, I get why they gloss over it.  Nobody likes a ‘What if?’ conversation about their health or thinking about the end of their life, but there is also a ton of disinformation online and so many “influencers” and firms out there that actively belittle the importance of insurance to sell their own strategy.  Plus, we’ve all heard stories of unscrupulous agents and “advisors” chasing a commission and making unsuitable recommendations.  In this article, I’ll be focusing on the top 3 objections and questions I’ve encountered as well as focusing on value points that consumers may not know.

1. “I have insurance through my employer, so why review it?”

During the planning process, this is the most common question I receive when conducting a review.  Sometimes no changes need to be made and other times understanding your policy and making a change can save thousands of dollars over the long haul.  According to a 2024 study conducted by LIMRA, over 53% of the American workforce have life insurance through their employer while only 27% say they are extremely knowledgeable on the subject¹.  To cite a current example, during the planning process with a new client, I asked them if they currently possessed life insurance.  My client told me that they had left their past role, were able to continue their original policy, and that they did not want to discuss new options or dig deeper.  No problem… until there is one.Fast forward one month, I received a phone call from this same client stating they received a bill for the next premium days ago… which showed a roughly 325% increase in premium from what they had been paying!  Now that the topic of life insurance was a priority, I was able to explain how while some group plans allow participants to continue coverage after separating from their employer, the premium never stays at the same level for long.  Despite being older than when they originally received group coverage (But thankfully remaining in perfect health), we were able to get them a term policy for the same face value with an A+ insurer at a premium that was in line with the original.  As individual term policies offer level premiums, they won’t have to deal with any surprise increases and could continue with peace of mind.

This story had a happy ending, but what if their health had deteriorated?  If the premium kept rising to unaffordable levels, then they would be forced to drop their policy and instead settle with the guaranteed amount offered through their new group plan… Though that would not be beneficial to their family if the worst did happen.  The point I’m trying to make is this- Don’t be the 73% that don’t understand the group life plan offered through their employer!  I’m rounding up from 12.7, but according to Bureau of Labor Statistics, people born between 1957-1964 have held an average of 13 jobs by age 56².  People change employers and not always by choice.  I think that point is abundantly clear unfortunately for any LinkedIn users that have noticed an uptick in “Open to Work” banners this year.  If nothing else, whether with your family or with the help of an experienced planner, educate yourself on what happens to your group life benefit if you separate from your employer (‘How much am I guaranteed and is it enough?’, ‘Will I lose it upon separation?’, ‘If I can keep it, what will it cost?’, etc.) and take action to eliminate those risks.

2. We don’t want to be caught off-guard and want to pursue Long Term Care but…

What follows ‘but’ can be any number of items.  In short, the conversation around Long Term Care, or LTC for short, is a necessary conversation that planners and clients alike seem to hate.  First things first, does everyone need Long Term Care?  No.  Should a planner even bring up the topic with a 25-year-old MBA with $100k worth of student loan debt and rent that eats up one of their bi-weekly paychecks each month or an individual with a $20M liquid net worth?  Not at all.  In the case of the former, a disability policy (Assuming their employer doesn’t offer it) would be beneficial to explore provided they’re the primary/sole breadwinner, in a labor-intensive field or their expenses eat up at least 60% of their annual salary.  Regardless, those aren’t the people that need to read this segment in the first place.  Those of you with assets to protect/pass on, a family history of LTC needs, and anyone who wants to ensure potential future care needs should read on.The headline of this section ended with ‘but.’  In my experience, the words following that have typically been a variation of the following: ‘but it’s expensive,’ ‘but I’m concerned about commission and conflict of interest,’ and ‘but I don’t want to put money into something that I may not even use.’  The last two comments?  I understand and don’t disagree.  It’s not absurd to have concerns about the compensation the recommending agent will make and totally understandable to not want to drop money into a solution that you may not even use.  To those with concerns regarding how much the agent makes from that recommendation, my advice is not to rely on your favorite influencer, TikTok, your buddy’s friend’s family member’s experience or the first page of Google.  If you see the value of LTC but don’t want to risk a ‘dud,’ look into a hybrid policy.  Many LTC providers combine care benefits with life insurance specifically for that point.  In that situation, if the insured were to pass and use some/none of the benefit, a lump sum payout would go to the insured’s heirs instead of the insurance company.  Some providers even offer ROP (return of premium) options for up to 70-100% of the premium paid if you do reconsider coverage or your situation changes.  For those concerned with agent/advisor pay?  See below.Look for a fiduciary, compare carriers, and ask them about their compensation structure.  If there’s a legitimate concern over how an LTC situation will affect you & your family’s lifestyle, and you aren’t being pigeonholed into one solution?  Fire off those questions!  If you’re interacting with a fiduciary, however, it’s beneficial to listen.  They aren’t trying to “make a sale”; they’re looking out for your best interest.  Remember- Just because they can earn a commission paid by the insurance company (not paid by you), that doesn’t necessarily mean that they don’t have your best interest at heart.  Even if they don’t make a commission, somebody is getting paid.  Whether that’s their boss, their firm, the firm/friend they referred you to, or a wholesaler.  If you’re being pressured or feel like it’s being pushed on you, then trust your gut and say no.  However, don’t let yourself be influenced by someone actively incentivized for you to say no dictate your decision.  And don’t work with someone who just asks how much you want to pay; work with someone that can help you analyze your cash flow and show you what’s in your budget and what your options look like.  That can also help you to identify unnecessary expenses and make better financial decisions overall.

So, it makes sense for you to invest in a policy?  Great… What type of policy is best, Indemnity or Reimbursement?  Without going into recommendation territory, it depends on you.  For example, with an indemnity policy, the insurance company will pay up to the max benefit amount if the insured cannot perform 2/6 activities of daily living (ADLs) such as getting in/out of bed, going to the washroom, transporting or bathing, etc., without assistance, directly to the insured if they can’t perform those ADLs by themself.  Reimbursement policies typically trigger payment off the same criteria but pay directly to the provider based on the cost of care… Meaning if your policy is showing a $7k/m benefit and your cost of care is $6k, then $6k is what it’ll pay out.  Meaning that while you won’t get the maximum benefit your illustration displays, you’ll get enough to pay for your care and (depending on the insurer) the option to increase the benefit after the first year as well as a slightly longer time benefit period than what your illustration is showing.  Contrarily, say an individual has a care cost of $6k/m and a max benefit of $9k/m on the indemnity front, then that individual can elect to take up to the full $9k and can use the excess $3k to help with non-care costs, such as mortgage payments and other bills, with no questions asked.  Yeah, that sounds awesome, but just remember- In 2024, the IRS pier diem limit on care benefits (And this combines with disability) is $410/day, or $12,470/month, which means that any amount received above that excess would be considered taxable.

The statement ‘long term care is expensive’ is another concern from clients, sometimes without even asking if they’ve planned for it.  We can all agree that care costs money, but I’ve often found that people don’t look at the expenses that arise from relying solely on your finances to tackle a long-term care situation.  IRA withdrawals are taxed at ordinary income rates, and there is no tax break on those withdrawals in Washington to pay for LTC, so someone whose main liquidity is based on their traditional IRA balance will increase their taxable income for the year and potentially put themselves into a higher tax bracket as those withdrawals are taxed at ordinary income levels.  On the other hand, those whose wealth is tied to company stock or non-qualified brokerage accounts may be in for a surprise if the plan is to sell securities to raise the funds when accounting for capital gains tax, both on the federal standpoint and potentially the state if you take Washington’s 7% tax on capital gains exceeding $250,000.  In that case, it would require the care recipient, their advisor, or their Power of Attorney to actively track their gains, employ tax loss harvesting, and mitigate mutual fund exposure to avoid surprise capital gains distributions.  Other than creating more work of themselves, both individuals in these examples would be sacrificing growth and increasing their tax exposure when a long-term care policy would have greatly simplified their lives and offset some or all their care cost on a tax advantaged basis.

“But Marc, how much does care cost?”  It varies based on several factors such as location, time, condition, and type of care.  If you don’t want to spend time googling the providers in your area to find out directly from them, I recommend using the Genworth website to get an idea of the average price in your area.  I’ve found their care calculator to be a useful tool to help people get a general idea of what to expect in the current year as well as in the future when accounting for inflation.  Keep in mind, however, that they list the average cost in your zip code/city of choice based on best facilities, average ones, and the not-so-great locations.  The true cost will vary based on the care provider and can be higher or lower than the price you’re seeing.   Cost of Long Term Care by State | Cost of Care Report | Genworth³

3. Is my life insurance opening me up to taxation?

Life insurance and how it pertains to taxation is a tricky subject because of the preconceived notions most people seem to possess.  For instance, everybody knows that the death benefit passes tax free to the insured’s heirs and that a policy’s death benefit isn’t included when calculating net worth.  The insurance companies have this information listed on their websites, so it’s true, right?  The answer might not be what you expect.  Death benefits aren’t subject to ordinary income rates, and typically a lump sum distribution won’t be taxed to your heirs.  Granted, if they elect to be paid in installments as some life policies and annuities allow, then the beneficiary would pay tax on the interest earned, but that’s essentially common sense.  Depending where that death benefit is going and how the ownership of the policy is structured, there may be unexpected gift tax obligations and taxes at state and federal level that could have been avoided with proper planning.Some of you may remember the Tax Cuts and Jobs Act of 2017 which basically more than doubled the amount one can give during their lifetime without incurring federal gift or estate taxes. In addition, the amount is indexed for inflation. A single taxpayer can claim a federal estate and lifetime gift tax exemption of $13.61 million. Couples making joint gifts can double that amount.  Unless Congress extends or modifies this, then this amount will drop to around $7M, adjusted for inflation, at the end of 2025.  For those reading that do not have a $7M estate or larger, you may be tuning out now.  However, Washington is one of 12 states that possesses a state estate tax separate from the federal levels, and ours is one of the lowest thresholds in the country that levies taxes on estates exceeding $2,193,000.  Attached is a link to Washington’s estate threshold list for those interested in reviewing the thresholds and potential expenses here- Estate tax tables | Washington Department of Revenue⁴.   From a Washington standpoint, or any state with a low threshold, how do we avoid life insurance from being a hinderance?First, naming a beneficiary.  If your beneficiary is listed as ‘my estate’ or ‘payable to my estate’, directly or indirectly, then you may have inadvertently opened your estate to taxation as that death benefit is now included in your estate.  The insurance company is still going to cut your heirs a check for that full amount, but the feds and the state are now calculating that death benefit as part of your total estate.  What’s more, you have now lost the advantage of naming someone as your beneficiary, which now opens the asset up to probate.  A living trust, on the other hand, keeps assets out of probate, but they aren’t tax advantaged vehicles.  If your life insurance is established in a way that may add to your estate tax burden, consider this second point

Appropriate titling and gifting.  This is typically done through the establishment of an ILIT, or Irrevocable Life Insurance Trust.  Unlike assets held under a living trust, an irrevocable trust is held outside of one’s estate, which means that the assets held in an irrevocable trust are no longer considered to be owned by you or your estate.  Rather than transfer your life insurance to an ILIT, can you instead name someone else as the owner of your policy?  Sure, you can do that.  Keep in mind that the ownership change is irrevocable.  Do you want to take the risk of the new owner mismanaging the policy, borrowing against it for their own needs, failing to make premium payments or losing it in the event of a divorce?  If not, look at an ILIT.  That way you can still maintain legal control over the policy while reaping the benefits of keeping it out of your taxable estate.  Bear in mind, the IRS implements a 3 year “look back” rule surrounding ILITs.  That means if you were to pass away within 3 years of the change you would lose out on any estate tax savings.  During this period, they will also be looking for “acts of ownership” such as premium payments continuing to be made by the original owner, borrowing against any cash value, and surrendering the policy.  So, if your existing life insurance isn’t already paid up, or if you were thinking of using term life, think again.  One solution that those with estates already subject to federal and state tax thresholds may consider would be premium financing.

In this scenario, a sizeable insurance policy would be purchased using borrowed funds, thereby allowing the individual to avoid using their own capital and sacrificing returns on their investments and opening themselves up to capital gains.  Using borrowed funds carries it’s own risks, however.  For instance, if the policy’s cash value underperforms and the loan balance exceeds the collateral balance, then the insured will need to post more collateral to avoid default.  And even if the loan is satisfied but the death benefit doesn’t grow as illustrated, that runs the risk of a lower-than-expected payout.  For high-net-worth estates considering premium financing, get your team together and see if this really makes sense.  Make sure your team can get you with someone that can keep the banks in check to avoid surprise increases on your loan and mitigate some of the risks associated with this strategy.

To reiterate my point from the beginning, life insurance is one of the most important pieces of a financial plan that planners and clients alike hate discussing.  Many planners out there, whether through the independent channels, wire houses and broker-dealers alike don’t even like to discuss it because many prospects seem to clam up with the topic arises.  Everyone has heard horror stories of shady sales practices, and nobody likes thinking about their own mortality.  Stop looking at insurance as an expense or comparing it to the stock market.  Instead, look at it how it’s supposed to be seen- A tool to mitigate risk and protect your assets, yourself, and your loved ones from an unexpected issue.  I hope that the information and tools I’ve listed helped to clear up some misconceptions and that those of you reading make good financial decisions.

Sources

https://www.limra.com/siteassets/newsroom/liam/2024/2024-liam-wpb-fact-sheet¹ LIMRA 7-18-24

NLS FAQs : U.S. Bureau of Labor Statistics² August 2023 study

Cost of Long Term Care by State | Cost of Care Report | Genworth³ Genworth LTC Calculator

Estate tax tables | Washington Department of Revenue⁴.

If you have questions relating to life insurance, the content of this article, or professional wealth advisory, Marc Bannos would welcome the opportunity to talk with you.  Mr. Bannos can be reached at (888) 860-0658 or mbannos@equilusfinancial.com.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.