Wealth transfer to children and even through multiple generations is one of the key concerns among affluent and high-net-worth individuals. The reasons are understandable: to be good stewards of wealth, whether built or received and to give their children better opportunities in life.
Often, such transfer-of-wealth planning commonly known as legacy planning, typically involves the use of insurance to create additional estate for distribution. Insurance products, namely term, whole life or universal life policies (ULPs), can be used for such wealth transfer, but ULPs are often touted as the holy grail for the wealthy.
What Are ULPs & Their Uses
A ULP is essentially a flexible life insurance that covers the entire lifetime of the insured, up to age 120 and builds cash value over time. It is flexible in that you can adjust the sum assured (death benefit) in the policy according to your needs, take out cash value for emergencies or retirement income, and even pledge it as collateral to the bank for loans. However, the main intent of ULP is to secure a huge death payout for estate purposes. Due to the significant size of the premium, ULPs are designed to serve those with a lot of resources.
Examples of Uses for ULPs:
(1) Creating Sizeable Estate for Distribution
Phillip has amassed a fortune of $10 million but would like to give $5 million to each of his three children (short of $5 million). To achieve an eventual estate of $15 million, he could either continue to grow his assets over time, which could be subject to investment risk, or purchase a single premium ULP to secure it immediately.
(2) Facilitating the Distribution of Assets That Are Hard to Divide
Sometimes, the assets held might not be easy to distribute or share among the beneficiaries, such as properties, businesses, heirlooms, or jewellery where the intention is not to sell off.
Henry has assets valued at $18 million to be shared equally among his three children.
The intention is for each child to fully own the asset in its entirety to prevent any dispute. However, it would not be possible to give the family business ($8 million) to one child without being unfair, as each child should receive $6 million instead (1/3 × $18 million).
Henry could purchase a ULP with a sum assured of $8 million using the $2 million cash and thereby increase his estate value to $24 million. In this way, each child can now hold the assets entirely, fairly, and with a greater inheritance. This strategy is also known as estate equalisation.
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In these two examples, we see that ULPs can be used to create the necessary estate if needed, as well as to equalise an estate where it is not easily divided.
Depending on the financial resources and aspirations for the legacy, setting aside significant capital for future gifting could result in less available for retirement. However, the right use of insurance solutions could create more for legacy gifting while still allowing for more in retirement.
ULPs Can Result in More for Both Retirement and Legacy
Suppose James has $8 million in assets and intends to give away $4 million to his children while keeping the remaining $4 million for his own retirement. Using the 4% withdrawal rule as a rough estimate, his $4 million retirement fund would translate to about $13,300 in monthly retirement spending, which increases with inflation.
On the other hand, James could create a $4 million legacy gift using insurance, which might cost about $1 million in premiums. This would leave him with $7 million in his retirement fund, equating to $23,300 in monthly retirement spending—a 75% increase!
Types of Insurance That Can Be Used for Estate Creation
While we have been referring to ULPs as a legacy instrument, there are also two other types of insurance to consider, namely term policies and whole life policies. Each of these products has its pros and cons.
1. Term Policy
For legacy planning, usually, a term policy that covers up to around age 99 is often used. Generally, a term policy is more suitable for those who prioritise lower costs, do not believe they will live beyond age 99 or are investment-savvy in growing their assets in the long term, using the term policy more as a hedge against dying early.
2. Whole Life Policy
A whole life policy offers the highest level of assurance in terms of lifetime coverage and coverage that increases over time to help preserve the time value of money against inflation. However, this type of insurance is the most expensive, making it less popular.
3. Universal Life Policy
Being flexible in allowing policyholders to adjust their coverage, premium payments and utilisation of policy cash value, as well as offering lifetime protection, ULPs remain the product of choice among the wealthy. However, unlike whole life policies, ULPs may face the risk of policy lapse due to poor policy performance. Even though this is a popular product, it is also a complicated one due to the policy structure, so it is important to understand the risks of this policy before committing to it.
Conclusion
A Universal Life Policy (ULP) is a financial instrument often used as part of legacy planning for estate creation and estate equalisation. When properly structured, it can also help to free up capital and boost your retirement at the same time. Besides ULPs, term and whole life policies, though less popular, might be more suitable for you, depending on your individual needs.
Speak to us for a review of your insurance needs with our complimentary InsureWell Assessment.
This is an original article written by Eddy Cheong, CEO of Havend.
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