One of the most important aspects of an estate plan is selecting the proper life insurance policy. The primary objective is to provide a guaranteed death benefit when estate taxes become due at the lowest possible cost. Grantors and trustees often ask what type of permanent life insurance is best to be owned by an irrevocable life insurance trust. To best address this question, one must first gain an understanding of the primary differences between whole life and universal life policies.
First, let’s explore the general terms of a whole life contract. The policy is designed to provide the face amount at death or as a refund of cash value at age 100. The internal performance of the policy must include interest crediting and dividends to meet the obligation of cash value refunding. Many insurance professionals view dividends as a return of excess charges. Neither the interest nor dividends are guaranteed.
A few decades ago, consumers realized they could outperform whole life policies by purchasing term insurance and investing the difference outside the insurance policy. In response to this trend, the insurance industry created universal life insurance.
The universal life policy creates an investment account that will fund annual renewable term insurance each year the policy is in force. This account will provide the additional funds needed in later years. As the internal premium expenses increase, the investment account or cash value will supplement the premium paid to keep the policy in force. The policy is not designed to pay the full death benefit as cash value at age 100.
Universal life policies are much more flexible because they do not have the obligation of substantial cash values or dividend payments. The investment account can be linked to a fixed account, indexed to stock markets or invested in mutual fund accounts.
In my experience, universal life insurance policies created to perform on guarantees are the best solution in most estate planning cases. These policies offer a guaranteed death benefit and low guaranteed premium. The policy is designed to build little, if any, cash value so trust funding problems rarely arise.
Further, the universal life platform allows easy modification to the contract to accommodate future changes in tax laws. For example, a couple with an estate of $4 million in 2011 will owe tax upon the death of the second spouse on about $2 million. Generally, they would purchase a policy for $900,000 or 45% of the $2 million excess. Their estate tax bill would reduce to $450,000 if the estate tax laws change to allow for $1.5 million per spouse. The trustee can simply lower the death benefit on the universal life policy and recalculate the required funding. This avoids medical underwriting so changes in health histories are irrelevant.
In conclusion, universal life contracts have many benefits in estate planning cases which involve life insurance. In many cases, universal life contracts are the superior choice in comparison to whole life insurance and the most suitable solution for estate planning.