Section 12.71 Letter to Clients

• Library: Estate Planning 2013 Forms

Letter to Clients

Mr. and Mrs. John Doe

1234 Broadway

Columbia, Missouri 65201

Re: Specifications and Considerations Involved in Purchasing New Life Insurance Policies for Your Estate Planning

Dear Mr. and Mrs. Doe:

This letter is intended to help you formulate your estate plan and to help you decide among competing insurance agents and life insurance policies. Before you purchase a new life insurance policy, you should understand a few important concepts. Please note the following:

1. Types of Insurance: There are as many different provisions in life insurance contracts as there are insurance companies. For this reason, it is easy to compare “apples to oranges” by mistake and thus not know if you are getting the most favorable policy. Because no two companies’ policies are identical, deciding which is the better bargain is difficult. But the following concepts are important in your planning:

a. The primary purpose of insurance is to provide liquidity and to replace or create wealth. Insurance is a gamble, that is, the insurance company gambles that you will live a long time and pay all of your premiums in a timely manner; when you purchase a policy, perhaps you are gambling that you are going to die in the relatively near future and, thus, your beneficiaries will receive more in death benefit proceeds than you will have paid out in premiums. Usually, the insurance companies win the bet and, hence, remain profitable.

b. You have two basic needs in obtaining life insurance at this stage:

(1) Provide some liquidity with which to pay federal estate taxes that would be payable if you die; and/or

(2) Provide liquidity and additional funds for living expenses in the event of the breadwinner’s death, because his or her salary would cease at death.

c. There are two basic types of insurance:

(1) Term life insurance or “pure” insurance

(2) Whole life or “ordinary” life insurance

Ordinary life insurance has a “savings” aspect in that you pay a lesser premium than would be due for a term policy at your respective ages. Term insurance is “pure” in the sense that the premium represents the pure actuarial risk of insuring your life as far as the life insurance company is concerned, plus an amount necessary to pay the life insurance agent the commission involved in selling the policy and make a small profit for the company. A term policy does not build up any cash value. Furthermore, the typical term life insurance policy eventually becomes prohibitively expensive as the age of the insured rises because of the statistical probability of the insured’s death within an increasingly short period of time. While a term life insurance policy may be cheap for a 25-year-old, it is expensive and perhaps almost impossible to obtain term life insurance on an 80-year-old individual.

d. Because the cost of insurance rises over time, insurance companies have developed programs whereby the savings portion of a premium is invested and eventually “pays up” the policy. In other words, the insurance company’s earnings from the additional cash deposited with it over the life of the policy permit it to continue to provide life insurance to the individual insured after the owner of the policy stops paying premiums. The insurance company plans these policies so that the earnings from the investment of the excess premium dollars permits the company to refund (in effect) some of those premium dollars to the insured at death while still permitting the insurance company to make a profit.

e. Some insurance companies do a better job of investing their funds than others. Some insurance companies have enjoyed better management over the term of their existence than others. Some of these insurance companies allow their policyholders to “participate” in these profits, and the policy dividends thus have the effect of reducing the cost of these policies over time.

f. As I see it, you need at least two different insurance policies to accomplish the estate planning goals we have discussed over the past several months. The first life policy you may need is a policy designed to replace wealth or provide estate liquidity if you and your spouse both die. You will recall that the federal estate tax provides for an unlimited marital deduction. Thus, gifts between spouses are not taxed. This means that there would not be any significant estate taxes due on the death of the first spouse; rather, only on the death of the second spouse would any significant amount of estate tax be due. Thus, any life insurance policy purchased with a view toward providing liquidity to pay estate taxes would be important only upon the death of the second spouse to die. It is possible to purchase this type of life insurance (a “second-to-die” policy).

g. Second-to-die policies can be term policies or whole life policies. Thus, you have to make the same type of decisions on a second-to-die policy as you would on a policy insuring just the life of one of you. Perhaps the best way to make this decision is to decide whether your need for this insurance is “permanent” or “temporary.” If you decide that your need is only temporary, a term policy will suffice. On the other hand, if you foresee that the need for this insurance will exist for as long as you have children who are dependent on you or for as long as you have to worry about funding a federal estate tax liability, a whole life type policy may be the best investment.

h. You will quickly learn that the premiums for a permanent (whole life) policy will be about seven times the premiums for a term insurance policy for the same amount of death benefit at your present ages. As time goes on, however, either the amount of term insurance available to you will decrease or the premium payable to maintain a specified amount of term insurance coverage will increase (or both). A whole life or permanent insurance policy, however, does not have this problem. Once the premium has been established, it remains fixed until the policy is paid up. Indeed, a whole life policy should build up cash value as time goes on more rapidly than just the amount of the...