Approximately $30 trillion in assets will transfer from Baby Boomers and Generation X to Millennials over the next couple of decades. A massive shift of wealth that will go primarily two places: The US Treasury and beneficiaries (Millennials or charitable causes). Of course, a part of any plan regarding the financial transfer of assets should attempt to minimize the amount due Uncle Sam and maximize the benefit provided to loved ones or charities of interest. A simple way to think about this opportunity is my “LOUIS and HENRY” presentation. LOUIS stands for “Loved Ones with Unnecessary Income Streams” (targeting Baby Boomers and Generation X) and HENRY stands for “High Earners Not Retired Yet” (targeting Millennials).
There are many potentially unneeded or unnecessary income streams that retirees have access to: Social security, pension income, IRA required minimum distributions, annuities, and many others. The strategy is really two-fold. The first is to take some of that unneeded income and begin to transfer that to the next generation in a tax-advantaged manner, which would be from LOUIS to HENRY pre-mortem. The other is for LOUIS to purchase coverage on themselves to prepare for the post-mortem transfer.
Let’s start with the unneeded income side. Everyone has heard of an IRA or annuity max strategy. If you haven’t, the concept is very simple. Required Minimum Distributions from an IRA that begin at age 70 1/2, force the client to take income which is taxed as ordinary income. Often times, the client doesn’t need that income to support their lifestyle, so they can choose to gift that income, spend it, or use it to purchase a life insurance policy. Same thing with an annuity max strategy, where a client can choose to take a withdrawal or annuitize and use the income to fund a particular plan. In more than 70 percent of variable annuity sales historically, the first distribution ends up being a death benefit. That is because the client doesn’t need the income and they keep it invested inside the annuity.
The annuity industry perpetuated this problem by offering the annual five to seven percent guaranteed build-up in some of these policies, creating an incentive for clients to let the funds ride as opposed to withdrawing or annuitizing. The annuity carriers paid heavily for that post 2008 as we all know, but those guarantees existed and, to some extent, continue to exist today whether it is an index or variable annuity. The same max strategies can apply to any income source, such as pension income, social security, or any other source. We, as the life insurance industry, need to help advisors identify these LOUIS maximization strategies and efficiently transfer assets to HENRYs both to minimize taxation and to create a sticky relationship for the advisor to maintain clients through the wealth transfer process. About 90 percent of children leave the financial advisor when the primary clients (parents) die. About 70 percent of spouses leave when the primary client dies (usually the husband). So this type of planning can help forge a “sticky” household bond that exceeds the scope of just one client relationship.
The first option is the annual gift exclusion amount that just increased to an even $15,000 per year. LOUIS (acting as a husband and wife couple) can gift the premium payment of $30,000 to HENRY who can then, in turn, purchase a cash value life insurance policy. They can do this every year for 20 years, amounting to a tax-free transfer of $600,000. The lifetime exclusion amount is $10,000,000 or $20,000,000 for a couple, so clients will likely have capacity to continue gifting as long as they wish.
With the great accelerated underwriting programs available today with Principal’s Accelerated Underwriting (AU), Lincoln’s LincXpress, Hancock’s ExpressTrack, and Pacific Life’s Executive Underwriting, getting a policy issued is easier than ever. If the client is between the ages of 20 and 60, and in good health, they can get a policy issued in as little as 10 days with no medical tests. These overfunded, accumulation designed policies, particularly IUL and VUL, can offer a tremendous opportunity for young people to save in a tax-advantaged manner while protecting their families with a death benefit. Advisors like this idea because they dig through their LOUIS clients, which many large institutions have programs to screen these people, and identify opportunities to bring new clients into their business, e.g. HENRY. It creates a new bond to the existing client and ensures that when LOUIS dies, the advisor will hopefully retain HENRY as a client. Including HENRY into this transfer planning process can strengthen the “stickiness” of that relationship because it starts to build the trust factor. It also helps to begin the planning process with HENRY for their own children at a time when the insurance cost (COI) is significantly less. This is all good for business from an advisor standpoint. With fee compression across the industry, making some life insurance commission on the side is good for the advisor’s bottom line as a supplement.
The second option is for LOUIS to gift a larger amount, over and above the annual $15,000, and incur the gift tax. Or for LOUIS to be the owner of the policy, with HENRY as the insured. That way LOUIS can purchase the policy on HENRY, who can go through an expressed underwriting process, and pay the premiums directly. This is a tad more complicated, having the insured and the owner different people, but it can easily be done. We just need to be able to prove an insurable interest, which isn’t hard in this family-centric situation. Additionally, for more complicated families, an irrevocable life insurance trust (ILIT) can be set up to own the policies and distribute any proceeds in accordance with what LOUIS wants. That requires some estate planning, but certainly is a way to achieve the desired outcome.
The point here is to get ahead of the game, before it is too late. Financial advisors need to begin to talk to every suitable LOUIS in their book and begin this gradual transfer to HENRY. Of course the more popular and obvious strategy is for LOUIS to purchase a policy on themselves, if they are insurable, for benefit of the HENRYs. The tax-free death benefit can be a great way to transfer wealth to the next generation. The same maximization strategies can be used to fund the LOUIS policy as well as funding the HENRY policies, of course depending on how much income LOUIS doesn’t need. An additional idea would be if LOUIS had a liquid financial asset they wish to unwind and use the proceeds to fund a policy. This would be what I would call the “outlier asset” funding strategy. A great example would be a large mutual fund position in Growth Fund of America by American Funds. That fund has been around a long time and has gathered quite a following. A client could have a $1 million position let’s say, and they wish to hold onto it until death for benefit of the children. They love the strategy and love the American Funds story.
The idea here would be to unwind some of the tax liability now, sell off a proportionate amount, and either buy a variable life insurance policy on themselves or gift the premiums for the kids to purchase on their own. Using a VUL policy with American Funds Growth ISF as a sub-account option, which has the same objective as the GFOA retail fund and shares some of the same managers, the client doesn’t have to give up the great American Funds story they love—now they own it in a more tax-advantaged manner. Four of the six managers for the Growth Insurance Series Fund also are on the management team for the retail Growth Fund of America and own nearly identical holdings. This could work for almost any major fund family and their respective funds within a variable life policy.
In conclusion, point of sale folks and BGAs in the field need to use a simple story to help prepare clients for this massive wealth transfer. This involves both pre-mortem and post-mortem planning, but both involve using life insurance to minimize the tax implications of said transfer. There is $30 trillion at stake and financial advisors need help—and my guess is they will be very grateful, as will their clients, that you stepped up to help them.
