With higher tax rates likely in the future, the insurance industry is seizing the moment to win business from wealth advisers.
“The insurance guys are all over me; they're constantly talking about the tax avoidance and tax deferral benefits of insurance,” said Frazer Rice, a wealth adviser at Wilmington Trust Corp. “Life insurance is becoming a very hot topic.”
Although agents have always em-phasized the benefit of tax-sheltered asset growth inherent in insurance and the fact that beneficiaries receive death benefits tax-free, today's low-interest-rate environment, volatile equity markets and looming threat of higher taxes make the insurance argument more compelling.
Among the specific strategies that sales representatives are emphasizing:
• Using variable-universal-life policies for tax-free retirement income, especially for those whose income exceeds the limits for a Roth individual retirement account.
• Adding insurance policies on top of charitable-lead annuity trusts as a way to mitigate the tax consequences of converting to a Roth IRA.
• Using insurance policies as a wrapper when investing in hedge funds and other alternative investments.
When taxes are rising, each of these strategies bears careful consideration, said Coventry Edwards-Pitt, an adviser at Ballentine Partners LLC, emphasizing the word “careful.”
“We're certainly looking at the strategies, given rising tax rates, but they're a little more complicated than they seem at first blush,” she said, noting insurance companies' linear assumptions for rates of return, their high fees and the penalties for premature policy cancellation.
Still, the benefits of a well- managed cash value life insurance policy can be attractive.
Brian Ashe, president of Brian Ashe and Associates Ltd., and treasurer of the LIFE Foundation's board, pointed out the advantages of one of his preferred strategies: funding a variable-universal-life policy until it has enough cash value to exceed what is put into it, and then taking tax-free withdrawals and loans to supplement retirement income.
“The money grows tax-free, you can withdraw it tax-free, take loans on it, and then when it matures as a death benefit, the death benefit is also income-tax-free,” Mr. Ashe said. “It becomes very attractive. You don't have to pay any taxes to supplement that retirement income.”
True enough, but that strategy works only with careful monitoring, pointed out Jared Levy, managing partner at KAP Planning Ltd.
“It's got to be done properly,” he warned. “You're not taking the policy out to create a death benefit, you're taking it out to create a tax-efficient vehicle, and therefore, you want to reduce the insurance as much as possible without depleting it.”
For investors who make charitable contributions to help offset the tax bite on Roth conversions, insurance agents suggest adding a life insurance policy to a charitable-lead annuity trust. With this strategy, life insurance is sold to a trust that is set up to deliver regular distributions to a charity. When the trustee dies and annuity payments are discontinued, whatever is left goes to heirs tax-free.
“There's been such a huge push to Roth conversions by the wirehouses that life insurance salespeople are asking, "How can we avoid that [tax burden]?' It's a way the industry is creating a concept around a very hot relevant topic,” Mr. Levy noted.
Private-placement life insurance — variable-universal-life policies that permit policyholders to invest in a variety of hedge funds and alternative investments — is the highest-end product on the market, suitable only for those with at least $5 million to invest. Investors who buy these products from carriers including American General Life Insurance Co., Massachusetts Mutual Life Insurance Co., New York Life Insurance Co. and Prudential Insurance Company of America are attracted by the tax shield they provide.
“At the tail end of last year, we started to see a lot more interest in this product, and the first two quarters of this year have been great,” said Robert Beauchamp, vice president of marketing at American General, who noted that he already has met his 2010 sales goals for the offering.
Mr. Rice said he likes the tax advantages that may be realized by using private placement insurance, but he's waiting to learn a bit more about the product before he wades in.
“Individuals investing in hedge funds pay through the nose in taxes,” he said, adding that the use of private-placement insurance “is an interesting strategy, but I'd like to see a few success stories.”
Like Ms. Edwards-Pitt, he believes that the tax advantages of insurance can be overplayed.
“Some people think that tax benefits are the icing on the cake of life insurance; others think they should be the cake,” Mr. Rice said. “I like being liquid as much as saving on taxes, especially when the tax savings aren't realized immediately.”
Ms. Edwards-Pitt said that while she prefers to use life insurance for its traditional purpose — providing liquidity to heirs at death — she's taking an appointment or two with insurance companies over the next few weeks to make sure she doesn't miss anything that might be to her clients' advantage.
“Everyone's out there thinking about what to do in a rising-tax environment and about the different efficient strategies they can employ. This is just one of the many things that are on the table,” she said.
E-mail Hilary Johnson at -hjohnson@investmentnews.com.
