Are You Overinsured? Don’t Make This Costly Mistake
Updated: Mar 3
Tax law changes could impact your insurance situation—leaving you with more insurance than you need or want.
Adopt the Super Rich strategy of “stress testing” your insurance strategy to determine what, if any, changes should be made.
You’ve got options—from sticking with your current coverage to restructuring it into a new policy to eliminating it altogether.
Guess what? You may be sitting on life insurance you no longer need—a lot of it, potentially. With some digging and the right analysis, it’s possible you could free up significant sums of money.
Here’s why: The tax law that was passed at the end of 2017 raised the estate tax exemption to approximately $11 million for individuals and $22 million for couples (until 2026). If you’re among the many who bought permanent life insurance for the purpose of one day paying estate taxes, this boost in the exemption could mean you won’t likely have an estate tax bill to pay. In that case, your insurance policy may have far more cash built up in it than necessary.
According to Jason Trenton, a top trust and estate attorney in the Los Angeles office of Venable LLP's Tax and Wealth Planning Practice, “The tax overhaul that occurred in 2017 has been a catalyst for many of our clients to revisit their estate plans. This has created an opportunity to substantially decrease their overall tax exposure. In addition, there can be tremendous savings by evaluating their current insurance and determining if their policies still make sense. Many of these were designed to pay for estate TAXES. With the increased exemption amount and some robust planning, we are finding this to be less of a necessity. The best result is driven by a comprehensive review with a coordinated team.”
But even if you purchased insurance for other reasons beyond an estate tax bill, it makes sense to revisit and “stress test” your coverage so you can determine whether or not you’re set up for long-term success.
When it comes to optimizing your financial life, it’s important to have access to all the different tools available—life insurance can be one of those tools. Sometimes the tools that you’ve used no longer make sense because of a change in your life or a change in legislation. This optimization process is ongoing—life is like a movie, not a still picture.
In this article, my colleagues discuss how the change in laws have reduced the need for insurance for many people, potentially saving you and your family a lot of money. In a future article, I will discuss a tool that drastically cuts the cost of insurance and creates a portfolio that grows tax-free. Legislation and technology create an ever-changing landscape.
The new tax law and its many changes are good reminders of the importance of revisiting your wealth plan from time to time. Here’s how to do it.
Revisiting Your Wealth Planning
It’s common for the Super Rich (those with a net worth of $500 million or more) to regularly re-evaluate their wealth planning. By doing so, they make certain they’re taking advantage of the smartest solutions available to them.
The evaluations almost always involve a review of their life insurance portfolios: Does their policy coverage match their needs? Often the answer is no and adjustments are made. The same goes for people with less wealth. Everyone should examine their plan periodically to make sure that what they have and what they need are in sync.
Occasionally, families are “oversold” life insurance. Consider the scenario where the life insurance agent projects the size of a person’s estate. It’s not a bad approach, presuming the growth rate is conservative and reasonable. Unfortunately, that’s not always the case. People end up getting too much insurance—and they pay for it.
The key is to make sure you have no more and no less death benefit than is necessary. Without a full re-evaluation, how will you know?
Evaluating Your Life Insurance
Get clear on your current life insurance situation with these three steps.
Step #1: Assess Your Policy
When you bought your insurance, you were given estimates about its future cash value and death benefit. Your first step is to see if your policy is performing as you were told it would with a special report, called an “inforce illustration.” This report spells out key financial information about your policy. With it, you may discover that your policy has built up value and benefits at a faster (or slower) rate than expected, or that it’s performing as designed.
Note: Interpreting inforce illustrations can be difficult—clarity isn’t always insurance companies’ strong suit. Even trained CPAs can end up scratching their heads over the data and how it’s presented. You’ll want to work with a financial professional who can help you navigate the information, draw conclusions and advise you with next steps.
Step #2: Evaluate the Strategy Used to Purchase Life Insurance
People can pay life insurance premiums out of pocket—or they can use a wealth planning strategy. Premium financed life insurance, for example, is purchased with borrowed money. It’s important to evaluate not only the life insurance policy itself, but also the underlying assumptions behind the financing approach.
Step #3: Determine What You Need and Want
The most difficult part of the process is determining the amount of death benefit that’s “just right.” Review your reasons for purchasing the life insurance in the first place. Make sure your reasons are still applicable and that circumstances haven’t changed.
Additionally, you’ll want to assess any new laws or broader developments outside your own life that could change the picture. As noted, the modification to the estate tax under the new tax law means that a lot of people who purchased life insurance (to pay federal estate taxes) may no longer need the coverage.
Finally, figure out how much death benefit you require going forward. Get clear on your goals (Do you want to leave money to heirs, for example?) and your expectations for the future (Do you think the current estate tax exemption amount will remain in place ten years from now?).
Advice: A professional advisor who understands life insurance can help you determine your goals and outline your options. For instance, a policy that is no longer needed for estate tax payments could potentially be used to pay for a buy-sell agreement with a business partner.
What To Do After the Evaluation
If your current insurance isn’t firing on all cylinders or it simply no longer reflects your current situation (or the one you’re likely to find yourself in down the road), start by considering your options:
Keep your life insurance policy as is. Say you determine you no longer need your policy for estate tax reasons, but that the money could go to your children. In that case, staying the course might be the best route.
Exit your life insurance policy. If your assessment reveals you do not need the money inside the life insurance policy, you can surrender the policy and take the cash inside. Or, you can make a life settlement where you sell the policy to a third party for cash. This approach can potentially give you more money than surrendering your policy.
Restructure or trade your life insurance policy. You may be able to modify your life insurance policy. This could entail reducing the death benefit if you decide you’ll need less money, thereby having the policy fully paid up. Or you might convert your current life insurance policy into another life insurance policy with different features that are more appropriate for your needs and goals.
Once you see the possibilities side by side, you can make a more informed decision.
If you’ve chosen to keep your life insurance policy as is, there’s nothing more to do. If not, it’s time to take action. Instruct your life insurance agent or other professional to implement your decision—whether it’s to exit your life insurance policy, restructure it, or trade your life insurance policy for another one.
The Value of Stress Testing
You may know you have too much insurance. But if you’re unsure—or even have an inkling you might be overinsured—it pays to “stress test” your situation.
Stress testing will examine your plan under pressure. It’s a proven way to make sure you’re not being misled by inexperienced or intentionally misleading professionals. It can also help you spot insurance mistakes you or a professional made in the past.
Example: People often end up buying more insurance than they need due to faulty assumptions about some aspect of the future. Say your business ends up growing at a slower rate than you expected when you bought your policy. In that case, you may be overinsured.
To stress test your life insurance, work with an expert in the field. This person should know how to interpret inforce illustrations and be able to provide alternatives to your current policy. Moreover, you’ll likely want your other trusted advisors involved in the analysis.
If you think you or a family member could potentially benefit from revisiting and “stress testing” your life insurance coverage, contact AG Asset Advisory at email@example.com. We’re here to get you coordinated with the right professionals.
Anthony Glomski is Founder and Principal of AG Asset Advisory (AGAA), an SEC-registered family office. Some of the information, data and opinions contained herein were not authored by AGAA and do not constitute investment advice. Content is provided solely for informational purposes only and therefore is not an offer to buy or sell securities, and is not warranted to be correct, complete or accurate. Additionally, neither the author nor AGAA are engaged in rendering legal, medical, accounting, financial, consulting, coaching or other professional service or advice in specific situations. This publication should not be utilized as a substitute for professional advice in specific situations. Neither the author nor AGAA may be held liable in any way for any interpretation or use of the information in this publication. Investing carries an inherent element of risk, including the risk of losing invested principal. Past performance is not indicative of future results.
Portions of this article came courtesy of my friends and colleagues at AES Nation, LLC.
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