Opportunity Obviously Cost Too Much and Your Long Term Care Decision

Opportunity Obviously Cost Too Much and Your Long Term Care Decision 

If you are out shopping for longterm care (commonly abbreviated as LTCI or LTC), I'm going to encourage you to take a look at a way of providing long term carebenefits that is probably new to you. On the other hand, if you are in the crowd that thinks they will never need long term care, I would also suggest you evaluate this line of thinking.

Dick and Jane are both age 65,recently retired and models of good health. They have ignored the long term care subject until recently. They just put Jane's mother, who is 88, into anursing home. Talk about sticker shock! She is in a nice place, but Dick and Jane are not 100% certain that her assets will allow her to stay there for the rest of her life.

Consequently, they have been out looking at long term care for themselves. They figure they can afford to insure a portion of what it might cost them if they ever need some form of LTCI, so they are looking at a benefit of $3,000 a month. The premium is around $4,200 a year.

Here's a new concept that Dick and Jane must become accustomed to now that they are retired. They both had good jobs during their working years. If they ever wanted to buy anything, it was just a question of looking at their income to see if they could swing the purchase. Pretty straightforward.

Now that they are retired, most of their expenditures are going to come frominvestment returns on the assets they have accumulated, not income from working. So they need to understand the difference between premium cost and opportunity cost. Here's what I mean-

If they elect to buy this $4,200 a year long term care policy, the money has to come from somewhere. Chances are it's coming from the interest earned on perhaps a CD or an annuity. But there is an opportunity cost associated with paying the premiums from earnings on any asset.

Let's say they are going to pay this $4,200 from the interest on a CD they own which is earning 5.4% interest. Since interest is taxable, and assuming they are in a 15% tax bracket, they would have to have $91,300 in that CD to produce $4,200 after tax to pay the premium.

They can't spend the $91,300. It can't grow. Basically, they have "committed" $91,300 of their assets to pay the premium on their LTC policy. That's the one "job" of this $91,300. The premium may only be $4,200 a year, but the opportunity cost is $91,300.

Let's take a look at another of their alternatives. It's called asset based long term care. How it works will unfold as I provide the example and contrast below.

One approach to asset based long term care involves re-positioning $91,300 of Dick and Jane's CD to a combination long term care/life insurance policy plan with an insurance company. Here's what moving this money does for them-

The money on deposit with the insurance company grows at interest, but it is tax-deferred interest so the insurance company will not send them 1099s every year for an amount they have to pay tax on like the bank is required to do. In 10 years, assuming current rates, the $91,300 will grow to $127,000; in 20 years $161,000. The CD, remember, does not grow, as its job is to spin off interest to pay the annual $4,200 premium on the traditional LTCI plan.

If either Dick or Jane needs any form of long term care, the insurance company plan will pay them $3,900 a month for 50 months--$900 a month more than the traditional plan.

But here's the real kicker.

If Dick and Jane never need long term care, then the camp that doesn't buy it would have been right. If Dick and Jane bought the traditional long term careplan, in 10 years they would have paid out $42,000 in premiums and about $7,400 in taxes on their CD interest in order to net out the required premium. That's a total of $49,700. The $91,300 portion of their CD would still be $91,300.

However, if Dick and Jane never need long term care, chose the asset basedlong term care plan and both die, for example in 10 years, the outcome is different. They have paid no annual premiums and the life insurance company will pay about $198,000 tax free to their kids.

Which sounds like a better plan?

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Completely Five Uses For Survivorship Life Insurance

Completely Five Uses For Survivorship Life Insurance

Survivorship life insurance is a life insurance policy that insures two people and pays at the second death. Also referred to as second-to-die life insurance, commonabbreviations are SWL for survivor whole life and SUL for survivor universal life.

Advantages

Since the insurance company does not have to pay until the second person dies, the premium is lower.

The insurance company could issue a standard policy, even if one person has health issues. In extreme cases where one person is entirely uninsurable, apolicy with an acceptable premium is possible.

There are many uses for a survivorship life insurance policy. Let's look at five.

Estate Taxes

Life insurance is the least expensive method of providing cash for the payment of estate taxes. Since 1981, the law allows one spouse to transfer all their property to the other spouse at death tax free. This is the "unlimited marital deduction." If there is an estate tax due, it is not due until the second spouse dies.

In response, life insurance companies designed the survivorship life insurance contract. Since the premium is lower, it is even a better solution than a policyinsuring only one person.

Replacing an Asset Given Away

Charitable remainder trusts (CRTs) allow a person to sell a highly appreciated asset (stock, land, a business etc.) without paying a capital gain tax, receive an income tax deduction and convert the asset to an income. At their death, the asset passes to the charity, not to their heirs.

An easy way to circumvent the children's disinheritance is to insure mom anddad with a survivorship life insurance policy for the value of the asset given to charity. Sometimes premiums can be entirely paid from the income from the charitable remainder trust, which is often found money if the original asset was illiquid. The income tax deduction can be spread over six years if the asset contributed to the CRT is large enough. This is another premium source.

Even Out an Inheritance

A couple has three children and a family business. One of the children is active in the business and the other two have careers of their own. If the bulk of the estate is the business and the plan is to leave the business to the active child, the other two children come up short.

A second-to-die policy on mom and dad can even things out. For example, let's say the total estate is 6 million and the business represents 4 million. If the parents leave the business to the active child and the remaining 2 million to the other two children and name these children the beneficiary of a 6 million dollar survivorship life policy, everything is equal.

The child active in the business gets the business worth 4 million. The other two children inherit 1 million apiece from the balance of the estate and 3 million apiece from the survivorship life insurance policy.

Post Phone a Buy Sell

If Joe and Bill were equal partners in a business, good planning would have them meet with their attorney and accountant, put a value on the business that each are happy with and have a buy-sell agreement drawn. Fund the agreement with life insurance and the funds are assured for the buy-out.

However, what if Joe's wife, Ann, is also active in the business? If Joe dies, Ann would inherit Joe's interest and continue to work in the business as usual. In this case, it would make sense to use a survivorship life insurance policy to insure both Joe and Ann. The buy-sell agreement would be worded to trigger the buy-out at the second of their deaths.

To Pay the Income Tax on an Inherited Qualified Plan

This is the day of mega 401(k) plans. When a 401(k), IRA or other qualified plan is passed, for example, to the children, income tax is required upon a distribution.

Most people do not realize the large potential tax on what may be their largest asset. Let's look at the worst case. If the qualified plan money is subject to the top estate tax bracket, which is currently 45% and the child is also in the top income tax bracket, currently 35%, the amount left to the child is only a fraction of the total amount. Note there is a deduction against income for estate taxes paid. A good estimate of the net total percentage paid in taxes at the top brackets is 70%.

Use a survivorship life insurance policy to offset the income tax on the distributions, the estate tax or both.

There are many other uses of survivorship life insurance policies. If your situation includes any of these examples, I would recommend looking at the use of a second-to-die policy.

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ILIT - Your First Irrevocable Life Insurance Trust

ILIT - Your First Irrevocable Life Insurance Trust

Irrevocable Life Insurance Trusts (ILITs) are planning tools used to keep life insurance proceeds outside of the taxable estate.

For example, if a married couple has an estate of 6 million, they can pass 4 million to the next generation with no tax if they set up the proper trust arrangement to take advantage of the maximum lifetime unified credits. That leaves 2 million still subject to tax under the current law.

The logical thing to do is to purchase a survivorship life insurance policy for the projected tax. However, a policy purchased in the manner most people are familiar with, the problem is not solved; it is compounded.

If the couple has any "incidences of ownership" in the policy, it will be included in the estate. The purchase of a one million dollar policy increases the estate to 7 million. Four million passes tax-free, but now the taxable estate is 3 million. This increases the tax by some $225,000.

Enter the Irrevocable Life Insurance Trust.

Attorneys draft Irrevocable Life Insurance Trusts. The trust will apply for its own Federal Tax ID number. The trust will then apply for the survivorship life insurance policy. It will be the applicant, owner and beneficiary of the policy. Typical wording is "The John and Mary Smith Irrevocable Life Insurance Trustdated April 5, 2007, JPMorgan Chase Bank, trustee."

In this example, since neither John nor Mary has any "incidence of ownership" in the policy, it will not be part of their taxable estate.

The Owner and Beneficiary

As opposed to using an ILIT, I have worked with a few cases where the only child or children are the owner and beneficiary. This may work. However, each year the parents gift the money to pay the premium, there is no assurance that the money will be used to pay the premium. Furthermore, the children, as owners, have access to the cash values. An ILIT has much more assurance.

I have seen the trustee be a child, the couple's attorney, accountant or a long-time family friend. All of these will work, but an un-biased third party, such as a bank, is much better. If an individual is the trustee, name a bank as the successor trustee. Banks don't die.

The Crummey Letter

Typically, the life insurance premiums are paid by the parents in the form of annual gifts to the Irrevocable Life Insurance Trust. Currently (2007) a person can give up to $12,000 each year to as many people as they want without paying gift tax or having the amount subtracted from their lifetime exclusion. However, these gifts must be "present interest" gifts, which mean the recipient must have immediate rights to the gift.

Gifts to an ILIT, for paying premiums on a life insurance policy owned by the ILIT, are not "present interest" gifts. A "Crummey" letter qualifies the gift as a "present interest" gift. The letter is not crummy or poorly written; the letter takes its name from a court case initiated in 1968 by Clifford Crummey, who was trying to do this very same thing: make annual gifts present interest gifts. Ultimately, the outcome of the case required the use of a letter, now known as the "Crummey" letter.

A letter is sent every year to each of the beneficiaries of the ILIT. It simply states that a gift has been made to the ILIT and they can withdraw it if they want within a certain timeframe, usually 30 or 60 days. If they don't exercise this right, the gift becomes a present interest gift.

Obviously, there is an "understanding" between the parents and children to ignore these letters, as it is a part of the overall estate plan. The annual gifts and the ensuing yearly Crummey letters do not have to go to children with a legal capacity, such as age 18. I have seen letters written to 4-month-old babies. In this case, even though the baby was not able to read the letter or understand the estate planning rationale behind it, it did not exercise its right to the gift. Phew, another legal bullet dodged.

As you can see, it is very important to arrange for the annual drafting of these Crummey letters. Some banks' trust departments used to provide this service if they were the trustee of the trust. This was just a courtesy as they never would see or manage any of the life insurance proceeds.

The best bet is to have your attorney do the letters. I have one client whose law firm (under a written set of instructions) has the premium notice from the life insurance company sent to their firm, prepare and send the Crummey letters and then pay the premium. All the client has to do is open a letter each year from the law firm indicating a premium is due and send them a check. Other than that, they don't have to lift a finger. A nice service.

If you have an estate that will be subject to estate taxes and your advisors suggest a life insurance policy to pay the tax at a discount, make sure you evaluate the use of an Irrevocable Life Insurance Trust.

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Just One More Question For You! Do You Know What Hybrid Car Tax Deduction Is?

Just One More Question For You! Do You Know What Hybrid Car Tax Deduction Is?

Well, what is a hybrid car? A car that qualifies to beat all the pollution and treat nature as its friend. The government is also its friend. Get a relief for that car too.

The hybrid car tax deductionenables owners of a hybrid vehicle - that is cars that have a gasoline-powered engine and an electric motor -- it's a one time deal under the FamiliesTax relief act.

Cars bought between 2004 and 2005 can have the relief up to $2000 and $500 for cars to be bought in 2006.

Fortunately, a revised energy bill that was signed in August 2005, gives hybrid cars even more lucrative incentives. Due to this, a full dollar tax credit comes into play, much to the respite of the tax payers.
They should now postpone the purchase of their hybrid vehicle to 2006, and avail the tax credits. They are however restricted to only the first 60000 owners and so you now need to run to your dealer to be among the first ones.

Under the existing law, the value of the tax break depends on the tax bracketyou fall into because it is a tax deduction. Those who have purchased hybrid vehicles in 2004 and 2005 can clam a $2000 reduction on their 2004 or 2005tax returns. This deduction will give you a relief of $600 if you are in the 33% bracket but $300 if you are in the 15% bracket.

Vehicles prior to 2004 can also claim a relief but has to do so within the two years from filing of tax or three years from initial return date.

Claiming your tax deduction is relatively simple; you do not have to itemize the deduction in order to claim it, but you must use Form 1040. Your deduction should be documented underneath the form and be classified as 'Clean Fuel'.

See, your hybrid car not only saves the environment but puts a few dollars in your pocket too. What more can you ask from your high-brid car...

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The Most Obvious Ten Things the Average Person Does Not Know About Annuities

The Most Obvious Ten Things the Average Person Does Not Know About Annuities

Deferred annuities possess characteristics found nowhere else. They play an important part in seniors' portfolios.

Seniors hold billions of dollars in deferred annuities. However, my experience is that the average person knows little about the unique advantages of deferred annuities, much less the options they have during the holding period.

When you mention the term, "annuity", it typically conjures up thoughts of getting a small check in the mail every month from some insurance company. It is viewed as an income.

The vast majority, however, of annuities are of the "deferred annuity" variety. They are accounts designed to grow money over a period of time in a safe environment. Over 90% of deferred annuities are never "annuitized", that is, converted to that monthly check in the mail.

So let's take a look at some of the attributes of annuities and, in the process, clear up many misunderstandings about this vehicle.

Tax Deferred Earnings

Deferred annuities provide "triple compound interest." There is interest on principal, interest on interest and interest on the taxes you would have paid on an investment in a non-tax deferred environment.

For example, 6% which is taxable is equivalent to an 8% non-taxed return assuming a combined federal and state tax bracket of 25%.

Safety

While deferred annuities are not FDIC insured, like a CD with a bank, they are backed by the generally billions of dollars of the insurance company's assets. No big risks here.

A Competitive Interest Rate

Insurance companies normally set the interest rate for a deferred annuitycontract annually. You will find that it is usually one to two points above CD rates. So not only do you get a higher rate but the interest is tax-deferred, unlike a CD where you pay taxes on the interest each year.

Some deferred annuities offer a rate that is guaranteed for a number of years, such as five. If you think interest rates will fall, you can lock in today's rate.

Minimum Interest Guarantee

When you get to the end of your annuity time frame, if your annuity has not given you at least a minimum of (generally) 3% interest per year, then the insurance company will apply their minimum guaranteed rate. Nothing to get excited about, but at least you know that you can't lose money and there is a minimum interest rate that is guaranteed no matter what.

No Sales Charges

When you move money into a deferred annuity, 100% of the money goes to work for you from day one. There are no sales charges subtracted from your initial deposit.

No Annual Administration Fees

Some places to park money, like mutual funds, may have fees attached to the administration of the fund. Not so with deferred annuities.

Withdrawal Privileges

This is a source of major misunderstanding. Many people do not realize that their money is not as tied up as they think; there are a number of ways to access funds without surrender charge penalties.

1. First, there is the 10% annual free withdrawal privilege. Each year you can take out up to 10% of your account value free of any penalties.
2. If you ever need to go into a nursing home, most insurance companies will allow you to take out whatever you need with no penalty.
3. If your doctor diagnoses you with a terminal illness, you typically can take out any amount penalty free.
4. You can convert all, or a portion, to a guaranteed income. This can be for your life, your life plus another (i.e. husband and wife) or for a set number of years.

5. There are a handful of new products on the market which will set you up with a pay out at a guaranteed interest rate for the rest of your life, but also allow you to retain control of the principal. In other words, the annuity is never "annuitized."

The interest rate is typically a function of your age. For example, if you are 65, the interest rate is 5%; 70 would be 6%; 75 pays 7%.

Free of Probate

This feature will vary by state, but in those states in which this feature is applied, an annuity is not included as a probate asset. Hence it is free of any probate fees or any delays in passing the funds to your beneficiaries. The normal requirement, however, is that the annuity must have a named beneficiary.

Free From Creditors

Again, this will vary from state to state. If you live in a state where this applies, this is added peace of mind that the money in your deferred annuity is safe in the event of a financial reversal.

Surrender Charges

Folks who object to deferred annuities usually bring up the fact that there are surrender charges that make getting their hands on the money costly. To a certain degree this is true. In order for the insurance company to go on the hook for the guarantees in the contract, they need to put some strings on accessing the funds.

However, these surrender charges decrease over time. Eventually they disappear altogether. In addition, after you have held your contract for a certain number of years (five is typical), you can take all or some of the money out over a five (sometimes ten) year period with no surrender charges.

The bottom line is that the surrender charge issue can be circumvented in a number of instances. Remember, deferred annuities are longer term scenarios. You certainly wouldn't want to put emergency fund money or money you are going to use to buy a new car in two years into a deferred annuity contract to begin with.

So there you have it. Ten features of a deferred annuity, which will add to your understanding of this product.

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