“Your high-net-worth clients who self-fund LTC costs may face the unintended consequences of leaving less of a legacy to their children if out-of-pocket care expenses deplete their estates,” Pailip Herzberg and Jorge Padilla caution their fellow financial planning professionals in the February issue of the Journal of Financial Planning.
What’s more, the authors remind their colleagues, clients wanting to insure their long-term care risk may “seek more flexibility than what is typically offered with the features of traditional LTC policies.” A hybrid, or linked-benefit life insurance policy, the authors suggest, is one alternative solution.
Linked-benefit policies pair the benefits of a life insurance with those of long term care insurance. Advantages include:
1. Linked-benefit eliminates the risk of clients paying premiums for coverage they hope to never – and in fact may never – actually use.
2. Clients who already have ample savings to cover potential long term care needs (but who have no LTC insurance) can use life insurance to create a “tax-free bucket.”
3. The life insurance can lock in a payout for clients’ spouses, kids, or other designated heirs, even if the long term care benefits are never used.
Herzberg and Padilla issue a caveat concerning these hybrid policies – for high net worth clients close to or above the estate tax exclusion amount (currently $5.49 million), the death benefit proceeds from the life insurance may be subject to inclusion in the estate for tax calculations. The solution? An ultimate life insurance trust.
At Geyer Law, where our attorneys are accustomed to creating sophisticated strategies for our high-net worth clients, we were happy to note the cautions about avoiding the triggering of estate tax which these two authors were careful to insert in this article even while explaining the many potential benefits of ULITS:
How does a ULIT work?
Technically, an ultimate life insurance trust is a “defective trust” that allows the insured to access funds from the trust using collateralized loans that are charged an interest rate. The incurred interest charges may be allowed to accumulate or set to be paid back prior to the death of the insured. Any remaining life insurance death benefit would be paid into the trust, with the estate repaying the loan outstanding before estate tax is calculated. Then, any remaining trust assets could be distributed income tax free to trust beneficiaries or used to pay estate taxes.
No money is ever received by the insured directly, so the clients avoid triggering “incidents of ownership”. The trustees create fully collateralized loans to the insured to help him/her pay long term care expenses, but the insured never actually directs the trustees to do any specific thing. What’s more, the trustee is fully subject to being removed by the grantor. Any LTC benefits are indemnity-based (providers are reimbursed directly with no money going to the insured).
“Handle with care” might be the warning label on every ULIT, so we were relieved to see the following warning included in the article for financial planning professionals: “Engage experienced and qualified estate planning attorneys to draft your clients’ legal documents,” Herzberg and Padilla caution, “and specify provisions in accordance with these relatively new insurance solutions.”