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FINANCIAL PLANNING


Shake Uncle Sam Off Your Coffin

03/26/01 11:40:20 PM PST
by Morley Hudson

Investing through variable universal life insurance can help preserve returns for your beneficiaries and lessen Uncle Sam's tax bite on your estate.

Max, who was born on May 18, 1996, is the beneficiary of Max Holdings, an irrevocable trust set up by his grandfather and mother. They each make a $10,000 annual gift to the trust and his mother, the trustee, purchased a variable universal life (VUL) insurance policy through the trust. With a total premium outlay of $56,000 plus the annual gifts to the trust, assuming a 12% annual rate of return, Max can take out low-interest loans from the trust to finance his college education, take out a loan of $60,000 at age 30 to start a business, and at age 50 withdraw $100,000 each year for seven years for his children's expenses. Further, at age 60, Max can borrow $500,000 from the trust each year till he reaches 85. This amounts to approximately $13 million. And the policy still has $15,226,028 in surrender value, or death benefit. It's hard to beat a deal like this.

You could assure this kind of security for your grandchildren by taking advantage of something called the variable universal life insurance policy. Before I tell you what that is, though, let me explain what trusts are.

TRUSTS

A trust is a legal entity, such as a partnership or corporation, that files its own tax returns and is operated by the trustee or co-trustees, the supervisors or administrators of the trust, with one person designated to act for the trust. Every trust has at least one trustee and one or more beneficiaries, usually children or grandchildren. The person who established the trust and initially put money or assets into it is referred to as the grantor or donor, although others can also make deposits. A beneficiary can also be the trustee, which means one of your children could be the trustee as well as the beneficiary of the trust.

Trusts are divided into two broad categories: revocable and irrevocable. A revocable trust is part of the grantor's estate and can be canceled or altered. Many families use this form of trust to assure that the management of family businesses and investments can continue if the usual manager -- generally the head of the household -- becomes mentally incapacitated due to accident, stroke, cancer, and so forth. Revocable trusts are also known as living, loving, or family trusts. If a married couple establishes a revocable trust, it becomes irrevocable when the first spouse dies.

An irrevocable trust is different in that it cannot be changed or canceled, with the exception of various administrative provisions, which the trustee can change at any time. In an irrevocable trust, all assets put in the trust must stay in the trust -- in other words, there's no getting it back; they cannot revert to the grantor or donor as they can in a revocable trust. There are various types of irrevocable trusts. These include life insurance, asset protection, generation-skipping, family bank, creditor-sheltered, and class trusts, to name only a few. Variable universal life insurance should be owned by a broad and very flexible trust, generally known as a wealth trust -- three trusts rolled into one: an estate tax-exempt trust, an asset-protection trust (which protects the money for your heirs after the life insurance has been paid off), and a generation-skipping trust at your children's option. A wealth trust should provide for, among other things, moving its base to another state, dealing with custodians of retirement plans, and making adequate provisions to deal with life insurance issuers and policy options.

THE VUL

The variable universal life insurance policy (VUL) may be the financial product of the 21st century, a veritable financial Swiss army knife -- a product that gives you a discreet, convenient, and economical way to invest. A Vul is a combination of:

1 Universal life insurance, which provides death benefit flexibility and premium payments, and
2 Variable life insurance, which provides flexibility in your investments.

You know what's even better? You don't have to worry about your grandchildren misusing the assets. They don't even have to know the VUL trust policy exists until you decide to tell them, since the income from the assets is tax-deferred and will not be reported to the Irs.

You can invest the cash value of the VUL policy in a stable of stock, bond, or money market funds. Earnings and gains accrued each year on invested assets are not subject to income tax. Even better, at the death of the policy holder, when the policy's accumulated cash value is paid as a death benefit and deposited into the trust, no income or estate taxes are due. Not only that, the trust will have full access to the policy's cash value in the form of interest-free loans (through the trustee) that do not have to be paid back because they will be deducted from the death benefit.

If you are a senior citizen considering life insurance to provide funds to pay estate taxes so you can pass on the value of your estate to your children and/or grandchildren, VULs are worth considering. They are akin to having a tax-sheltered mutual fund investment account with term life insurance benefits thrown in.

With judicious and careful investing, the value of your investments will increase, which in turn increases the value of your estate. A more valuable estate means higher estate taxes. With most life insurance policies your death benefit remains the same, but if you own a VUL policy, its cash value increases, which increases your ultimate death benefit, which should equal or exceed the increased value of the estate assets. Any investment growth is free of income tax and can be accessed by policy loans at a quarter of 1% of annual interest costs. If the VUL is owned by an irrevocable trust, it is free of estate tax and the death benefit is free of income tax.

WHAT TO LOOK FOR

When shopping for a VUL, focus on the number and type of mutual funds offered and the performance record of each of these funds over the past six months, one year, and three years. Then look at the annual costs listed in the insurance policy. Take special note of the mortality and expense (M&E) costs and surrender charges.

Any tax-sheltered investment -- that is, VUL, IRA, Keogh, 401(k), variable annuity -- with more than $10,000 invested should have a full-time, active investment advisor or money manager, if for no other reason than to get you out of the market during corrections and bear markets. Make sure you select an advisor or manager who:

1 Actively manages mutual funds and also the clone funds offered in Vuls and variable annuities
2 Has a good performance record (should average approximately 18% compound annual rate of return over a three-year or preferably a five-year period)
3 Continuously monitors market performance. You should have the flexibility to convert a position to cash painlessly.

CONCLUSION

When used correctly, VULs provide financial results that cannot be duplicated by any other financial product. Think of them as a self-directed, tax-advantaged, capital appreciation plan, which you could use to leverage estate and/or trust assets. So if you think Max is the only one fortunate to have a sizable trust, think again. You too can have grandchildren as fortunate as Max.


SUMMARY OF VUL FEATURES

1 A VUL is not vulnerable to the failure of the insurance company because the separate mutual fund accounts are held by a custodian bank and not co-mingled with the company assets.

2 In a VUL, you have tax-free access to account balances via very low-interest loans (a quarter of 1%) against cash value and ultimate death benefit.

3 No income tax is paid on loans against the account or cash value, provided the policy is set up as a non-modified endowment contract (non-MEC). To be considered non-MEC, you must be paid premiums over a period not exceeding seven years (usually a four-year minimum, with five years considered normal). Further, IRS regulations governing non-MEC contracts must be complied with by the insurance company to retain the virtually interest-free loans feature, which means that the actual net amount of life insurance in force varies, causing the life insurance cost to vary. (This is less than 0.5% of the annual total cost so it is not worth being concerned with.) Because the account or cash value can become very large, it is important to find a policy with M&E charge well under the 1% level -- preferably near 0.25% after the first 10 years that the policy is in force.

4 State insurance regulators and the Securities and Exchange Commission (SEC) supervise the financial stability and procedures of the insurance company.

--M.H.


Morley Hudson is a mechanical engineer and former Louisiana State Representative. He is a retired estate executor, trust manager, and investment manager.



Copyright © 2001 Technical Analysis, Inc. All rights reserved.





Morley Hudson


Address: Undisclosed
Shreveport, LA 71106
Phone # for sales: 318 868 9405
Fax: 318 868 6555
E-mail address: morleyhudson@prodigy.net


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