Category Archives: Retirement Planning

Ideas to help preserve and grow your money

4 Reasons Why Not To Go Long The S&P

global investingMy Comments: Some of my responsibility as an investment advisor is to provide warning if I think there are pending changes in market direction. But since I have no idea what I may eat for lunch today, telling folks about the next crash will happen is pure speculation. But…

I compensate for this inability by having as much of their money as possible in accounts that have historically moved away from the markets and into cash and short positions when the signals are strong that a downturn is happening.

I’ve included only one chart from the article here. To the extent you want to see the rest, this link should take you to my source article: http://seekingalpha.com/article/2466765-4-reasons-why-not-to-go-long-the-s-and-p

Jack Foley, Sep. 3, 2014 2:43

Summary
• Many large cap stocks are not making new highs like the SPY. This is a worrying sign.
• Interest rates have to rise in the future which will put downward pressure on the stock market. Veteran trader Steve Jakobsen believes we could drop 30% from here.
• Oil seems to have bottomed and oil has the potential to make the whole commodity sector rally along with it.

The S&P 500 (NYSEARCA:SPY) has broken through the physiological number of 2000, and commentators and speculators alike are predicting higher highs from here. I am ultra short on this market but it is becoming increasingly hard to predict when this market will roll over in earnest. Investors who are short the market are really hurting right now, and it takes a brave investor to stay short in this environment. Nevertheless, the risk is all to the downside so an investor must stay extremely nimble if profits are to be made. Let’s explain why.

First of all, even though the market is making new highs, there are many large cap stocks that are not participating in this move. Look at the General Electric Company (NYSE:GE) to see how far it is below its all-time highs.
14-9-16 General ElectricAlso because we have extremely low interest rates, corporate earnings are inflated. Bonds and stocks have rallied hard for the last few years as these markets have been the benefactors of the US’s low interest rate environment.

Nevertheless, interest rates one day will have to rise. When they do, investors will start shifting their money back into fixed term savings accounts. Bonds trade inversely to interest rates so when rates rise, bonds will come under pressure. The problem with low interest rate environments is that they can create asset bubbles. I believe we have one forming in stocks, in bonds and in certain real estate markets globally. In London, for example, property prices may rise by 30% this year which is unprecedented in a struggling global economy we have nowadays.

Veteran trader Steve Jakobsen believes that we could see a 30% drop in the S&P 500 from these levels. Jakobsen believes that equities is the only asset class that hasn’t been really affected from this ongoing global financial crisis.

Therefore, he believes one day the S&P 500 will revert to the mean which could be as much as 30% lower than where we are now.

Finally, I like the movement oil is making at the moment and I think we have finally found a bottom. Tthe spot price of light crude oil has gone from $108 in June to a rising $95 at the moment. The bottom seems to be in and if oil can rally from here, I believe it will put pressure on the stock market as funds will start to leak into the commodity markets. Oil has the potential to take the whole commodity complex with it when it’s in bull mode, so depressed agricultural commodities such as Corn and Sugar should also benefit. As you can see from the chart below, commodities have struggled as a whole in the last few years as equities have rallied hard.

Yes, equities and oil can rally together and have done so up to January 2013 since 2008 (practically everything rallied once the Fed ran their printing presses) but since January 2013 oil has not participated in the move. Once the Federal Reserve eventually ends all stimulus programs (either voluntarily or by demand), I have no doubt capital will start leaking into the commodity markets and oil. Also if geopolitical tensions in Iraq and the Ukraine escalate, oil will spike and the world stock markets will decline sharply.

To sum up, there are enough warning signals to warrant not being long here in the US stock market. If you still think the rally is not finished, I would advise scaling down your position size.

For Retirement Portfolios, a Smarter Glidepath

retirement-exit-2My Comments: I’ve talked in earlier blog posts about the rate used to withdraw money from your retirement accounts. There is a prevailing sentiment that it should be 4% or less. I think that’s too low. On the other hand if I’m wrong, and 30 years later you discover you have run out of money, it’s unlikely I’ll be here to take your blame.

Having said that, I think a 6% extraction rate is more realistic. Only how much more money that actually gives you is hard to imagine. That’s because it’s a function of how fast the money left in your accounts actually grows.

My experience, though thick and thin, meaning good years and bad years, is that you should be able to grow your money at 7 to 8% per year. I’m now using programs that when backtested over the past dozen years, which includes the crash of 2008-09, have grown at 10%.

The argument against that is that as we all know, past performance is no guarantee of future performance. But it is a clue, and with advances in technology and tactical approaches to investing, a higher number is far more realistic, in my opinion.

by Michael Kitces / AUG 25, 2014

One of the core functions of financial planning is setting up clients’ portfolios in retirement so that resources are adequate to sustain the journey — no small feat, given the uncertainties involved and the need to balance stability and safety against the risk of inflation, as well as the need for growth over the potentially long time horizon.

Conventional wisdom suggests that retirees should manage this challenge by having a moderate exposure to stocks at the start of retirement — to help their portfolio grow and be able to keep up with inflation over the long run — and then reduce equity exposure slowly over time as they age and their time horizon shrinks.

But recent research has suggested that the optimal approach might actually be the opposite — start with less equity exposure early in retirement, when the portfolio is largest and most vulnerable to a significant market decline, and then slightly increase the equity exposure each year throughout retirement.

And as it turns out, an even better approach may be to accelerate the pace of equity increases a bit further in the earlier years (from an initially conservative base). After all, a slight equity increase in the last year of retirement isn’t really likely to matter.

For instance, a glidepath might aim to increase equities in just the first half of retirement, until the target threshold is reached, and then level off. Instead of gliding to 60% equities from 30% over 30 years, glide up to 60% over 15 years — then maintain that 60% equity exposure for the rest of retirement (assuming the 60% target is consistent with client risk tolerance in the first place).

Accelerating the glidepath reduces the time when the portfolio is bond heavy — a particular concern in today’s low interest-rate environment. And it may be even more effective to simply take interest-rate risk off the table altogether by owning short-term bonds instead. Such an approach leads to less wealth on average, but in low-return environments, rising-equity glidepaths that use stocks and Treasury bills can actually be superior to traditional portfolios using stocks and longer-duration bonds (say, 10-year Treasuries) — even though Treasury bills provide lower yields.

FASTER GLIDEPATH

In the original research that American College professor Wade Pfau and I collaborated on, showing the benefits of a rising-equity glidepath, we simply assumed that any retiree using a glidepath would make adjustments in a straight line throughout retirement. For instance, gliding equities to 45% from 30% during a 30-year retirement time horizon would require a shift of 0.5% per year.

Gliding to 60% from 30% in the same time horizon would involve shifting 1% per year.
Yet the reality in such situations is that, for someone who is spending down assets, the last 1% change in equity exposure (to 60% from 59%) in the 30th year is not going to impact the outcome. At that point, the retiree has either made it or not.

So we launched a follow-up study, testing the impact of an accelerated glidepath. In this case, instead of moving to 60% equities from 30% over 30 years, the retiree moves there in only 15 years (at 2% per year), and then plateaus.

To test the alternatives, we looked at how they would have performed historically compared with each other with a 4% initial withdrawal rate over rolling 30-year periods in the U.S., starting each year since 1871, assuming a combination of large-cap U.S. stocks and 10-year Treasury bonds that are annually rebalanced.

The results, shown in the “How Fast a Glidepath?” chart below, reveal that the accelerated glidepath over 15 years is superior to the 30-year glidepath. In most years, the difference is fairly small — an improvement of the safe withdrawal rate of 0.1 to 0.2 percentage points — but in the best years, the improvement was as much as roughly half a percentage point.

The accelerated glidepath is ultimately better in all historical scenarios and improves outcomes in both high-return and low-return eras. It’s only a question of how much.

INTEREST-RATE RISK

A commonly voiced concern about our original rising-equity glidepath research was the fact that being more conservative with equities in the early years also means owning more in bonds. That’s not necessarily appealing in light of today’s low interest rates and the fear that rates will rise at some point in the coming years.

Accordingly, in our follow-up research we also tested the impact of taking interest-rate risk off the table, by using portfolios of stocks and Treasury bills, instead of stocks and 10-year Treasury bonds. The benefit of using Treasury bills is that, because they mature in a year or less, they are reinvested annually, avoiding any risk that the retiree will need to liquidate bonds at a loss because of rising rates. The downside, of course, is that shorter-term Treasury bills generally have lower yields over time (at least in any normal, upward-sloping yield curve environment).

As shown in the “Bills vs. Bonds” chart below, there are times when Treasury bills help, and times when they hurt. The difference in outcomes between using Treasury bills and bonds is as much as a half-percentage point improvement in safe withdrawal rate, and as bad as a 2-point decrease. ( No chart here. Please continue reading by clicking HERE )

New Longevity Annuity Rules: 5 Things to Know

retirement-exit-2My Comments: Earlier this week I introduced the idea of a QLAC. If you didn’t see it, click on the link and check it out.

Some of you are going to want to use this contract as soon as it becomes available this fall. Others are going to think about how your investment mix will change today so that money in a QLAC is maximized by the time you are 85 years old.

Another reason for consideration is that while annuities are a contentious topic, they have their advantages. Some advisors swear by them; others say the fees will kill you. In my opinion, they have their uses when clients are fearful of how life might play out and the insurance element built into annuities provides a peace of mind dividend that can be found in no other product or investment.

What these new rules do not appear to include are 403(b) accounts, which are very common here in Gainesville. That’s because a 403(b) is a generic equivalent of a 401(k), but for the non-profit world only, such as the University of Florida or Santa Fe College. The answer may be to transfer money out of your 403(b) into an IRA at retirement, with up to 25% going into a QLAC.

By Nick Thornton July 15, 2014

Retirement account holders can now put 25% of their money in QLACs.

In recognition of the reality that many Americans will live well into their 80s, the Department of Treasury recently issued final rules making Deferred Income Annuities more accessible to those with good genes and perhaps inadequate savings.

The rules could be a game changer for how boomers, and their advisors, allocate 401(k) and IRA assets going forward.

Here is a breakdown of the core provisions to the new regulations governing DIAs.

1. Defined contribution participants and IRA owners are now allowed to invest up to 25% of their account balances, or up to $125,000, in qualifying longevity annuity contracts, or QLACs. That money will not be subject to the annual minimum distribution requirements governing 401(k) and individual retirement accounts that begin at age 70 1/2.

2. Longevity annuities will distribute cash at a set age, typically by 80 or 85. If the owner of the annuity happens to die before they begin to receive benefits from the annuities, all is not lost. The principal and premiums paid on the contract will be returned to the retirement account, where the money is subject to the same laws governing the inheritance of retirement accounts.

3. In the event that investors, and or their advisors, inadvertently distribute more than the 25 percent limit to a deferred annuity, the IRS will allow the mistake to be corrected without disqualifying the annuity contract.

4. Lump-sum investments can be made into QLACs, or, salary deferrals can be incrementally made into the contracts, much as they are with a 401(k) plan.

5. Ultimately, the cash value of QLACs is subtracted from the rest of a retiree’s assets in a 401(k) or IRA when determining the required minimum distributions when they take effect.

5 QLAC Questions and Answers

My Comments: QLAC? What the heck is a QLAC?

By Jeffrey Levine / July 18, 2014

On July 1, 2014 the Treasury Department released the long-awaited final regulations for Qualifying Longevity Annuity Contracts (QLACs). These new annuities will offer advisors a unique tool to help clients avoid outliving their money.

The QLAC rules, however, are a complicated mash-up of IRA and annuity rules, and clients may need substantial help in understanding their key provisions. To help advisors break down the most important aspects of QLACs, below are 5 critical QLAC questions and their answers.

1) Question: What are QLACs?
Answer: QLACs, or qualifying longevity annuity contracts, are a new type of fixed longevity annuity that is held in a retirement account and has special tax attributes. Although the value of a QLAC is excluded from a client’s RMD calculation, distributions from QLAC don’t have to begin until a client reaches age 85, well beyond the age at which RMDs normally begin.

2) Question: Why did the Treasury Department create QLACs?

Answer: Prior to the establishment of QLACs, there were significant challenges to purchasing longevity annuities with IRA money. The rules required that unless an annuity held within an IRA had been annuitized, its fair market value needed to be included in the prior year’s year-end balance when calculating a client’s IRA RMD. This left clients with non-annuitized IRA annuities with an inconvenient choice to make after reaching the age at which RMDs begin. At that time, they needed to either:
1) Begin taking distributions from their non-annuitized IRA annuities, reducing their potential future benefit, or
2) Annuitize their annuities, which would obviously produce a lower income stream than if they were annuitized at a more advanced age, or
3) “Make-up” the non-annuitized annuity’s RMD from other IRA assets, drawing down those assets at an accelerated rate.

None of these options was particularly attractive and now, thanks to QLACs, clients will no longer be forced to make such decisions.

3) Question: How much money can a client invest in a QLAC?

Answer: The final regulations limit the amount of money a client can invest in a QLAC in two ways: a percentage limit; and an overall limit. First, a client may not invest more than 25 percent of retirement account funds in a QLAC.

For IRAs, the 25 percent limit is based on the total fair market of all non-Roth IRAs, including SEP and SIMPLE IRAs, as of December 31st of the year prior to the year the QLAC is purchased. The fair market value of a QLAC held in an IRA will also be included in that total, even though it won’t be for RMD purposes.

The 25 percent limit is applied in a slightly different manner to 401(k)s and similar plans. For starters, the 25 percent limit is applied separately to each plan balance. In addition, instead of applying the 25 percent limit to the prior year-end balance of the plan, the 25 percent limit is applied to the balance on the last valuation date.

In addition, that balance is further adjusted by adding in contributions made between the last valuation and the time the QLAC premium is made, and by subtracting from that balance distributions made during the same time frame.

In addition to the 25 percent limits described above, there is also a $125,000 limit on total QLAC purchases by a client. When looked at in concert with the 25 percent limit, the $125,000 limit becomes a “lesser of” rule. In other words, a client can invest no more than the lesser of 25 percent of retirement funds or $125,000 in QLACs.

4) Question: What death benefit options can a QLAC offer?
Answer: A QLAC may offer a return of premium death benefit option, whether or not a client has begun to receive distributions. Any QLAC offering a return of premium death benefit must pay that amount in a single, lump-sum, to the QLAC beneficiary by December 31st of the year following the year of death.

Such a feature is available for both spouse and non-spouse beneficiaries. In addition, the final regulations allow this feature to be added regardless of whether the QLAC is payable over the life of the QLAC owner only, or whether the QLAC will be payable over the joint lives of the QLAC owner and their spouse.

QLACs may also offer life annuity death benefit options. In general, a spousal QLAC beneficiary can receive a life annuity with payments equal to or less than what a deceased spouse was receiving or would have received if the latter died prior to receiving benefits under the contract. An exception to this rule is available, however, to satisfy ERISA preretirement survivor annuity rules.

If the QLAC beneficiary is a non-spouse, the rules are more complicated. First, clients must choose between two options, one in which there is no guarantee a non-spouse beneficiary will receive anything; but if payments are received, they will generally be higher than the second option.

The second option is a choice that will guarantee payments to a non-spouse beneficiary, but those payments will be comparatively smaller than if payments were received by a non-spouse beneficiary under the first option. Put in simplest terms, a non-spouse beneficiary receiving a life annuity death benefit will generally fare better with the first option if the QLAC owner dies after beginning to receive benefits whereas, if the QLAC owner dies before beginning to receive benefits, they will generally fare better with the second method.

5) Question: Are QLACs available now
Answer: Yes…and no. Quite simply, the QLAC regulations are in effect already, but that doesn’t mean that insurance carriers already have products that conform to the new IRS specifications.

To the best of my knowledge, and as of this writing, QLACs exist in theory only.
It’s likely, however, that in the not too distant future, QLACs will go from tax code theory to client reality. Exactly which carriers will offer them and exactly which features those carriers will choose to incorporate into their products remains to be seen.

But make no mistake: QLACs are coming (or here, depending on your point of view). If such products may make sense for clients, it probably makes sense to reach out to them now and begin the discussion.

6 Strategies to Reduce Your Need for Money When You Retire

retirement_roadMy Comments: These might seem like a no brainer. The financial media is awash with articles talking about how Americans simply don’t have enough money to retire. In the larger perspective, this, if true, is going to put enormous pressure on the government to subsidize the living cost of those who run out of money.

We’ve already talked about how simply leaving people by the side of the road to die is not an option. Even though there are some politicos who want that to happen; they don’t have what it takes to work together and figure out how to avoid it.

Most of us agree that it’s a personal responsibility to pay our own bills, and not rely on handouts. All of us agree, however, that Social Security benefits are already critical to our well being and that without them, millions of Americans would be on the streets, waiting to die.

The pressure on the system is going to grow, just like the pressure on the VA system has created tensions that need to be addressed. The dilemma is that demographics is not a simple variable. By the time most of the boomers come to an end, there will be a time of relative plenty, until such time as the children of the boomers reach retirement age, and then it will start all over again. In the meantime…

by Andrew Schrage on July 16, 2014

When you’re discussing retirement savings strategies with your clients, it’s important to emphasize that they should save as much as possible for their golden years. Of course, that amount varies greatly from person to person, and regardless of an individual’s ability to save, it’s always wise to be thrifty, even during retirement. Fortunately, there are a variety of strategies available that can help your clients reduce how much money they’ll need once they retire and call it a career.

1. Get the home paid off

Whether your client is 30 or 50, have them implement a game plan to pay off their mortgage prior to retirement. Even if they plan to move during retirement, this is a good strategy. If they buy a new home when theirs is paid off, they can avoid a new mortgage, and if they’re downsizing, there will be equity on the table.

One option to consider is refinancing into a 15-year loan. In many cases, it is possible to do so without significantly raising the payment. If that’s not doable, encourage them to start paying more each month. ( another option is to find a way to make 26 bi-weekly payments a year. This has the amazing effect of turning a 30 year mortgage into a 24 year mortgage)

2. Eliminate car payments

Though I am personally years away from needing a new set of wheels, I’m already saving for one in a dedicated bank account. When the time comes to make the purchase, I’ll pay for my new car in cash, and will therefore avoid paying interest. ( but not in cash; cash means lower purchasing power down the road as inflation is going to happen regardless)

Encourage your clients to do the same so that they can always pay for a new car with cash. Proper budgeting to free up money to set aside each month is crucial.

3. Get healthy now, and stay that way

Emphasize the importance of exercise and a healthier diet to your clients. ( avoid too many carbs, eat more fat, and drink some red wine! ) Reducing drinking and smoking and getting on a regimented fitness plan can result in long-term financial gains. According to Fidelity, a retired couple can expect to incur $220,000 worth of expenses for health care alone, but that number can be significantly lessened by staying in optimal physical shape.

4. Enjoy low-cost activities

Trips to Tuscany and motor home treks across the U.S. are fun and exciting, but your clients have a budget to worry about. Extravagant vacations can be taken only if their finances can afford it, but in general, they should look for other low-cost activities. The local library has a wealth of programs available, including exercise clubs and courses on how to navigate a PC, and they also have plenty of DVDs available for free rental. Even inviting the kids over for a potluck can occupy a day of entertainment. Volunteering is also a worthy endeavor that is fun and satisfying. Check serve.gov for more volunteering opportunities.

5. Travel in a budget-friendly style

For local travel, Amtrak offers discounts for seniors, and American Airlines discounts select fares by as much as 50 percent for retirees. Timing is also essential to curb travel costs. For example, October to April is the busiest time of the year for people to travel to Florida, and your clients should avoid such peak times to cut travel costs. For more affordable international travel, your clients can try Costa Rica from May to November, or Sydney in the autumn or spring.

6. Put off applying for Social Security

As you probably know, your Social Security benefit increases by 8 percent each year you delay after full retirement age. Make sure your clients know this. Delaying retirement and working longer can significantly boost Social Security income. ( call or email me for a free report that will tell you which one of the 97 months from age 62 to 70 that will give you the most money )

What other tips can you suggest to reduce retirement expenses?

25 Things You Should Do Before You Die

My Comments: This appeared in a financial planning magazine and really doesn’t need any comments from me. I’d only mess it up.

Well, wait a minute. Years and years agao, before computers, social media and instant messaging, I read that every man should achieve three goals. They were to build a house, father a child and write a book. My book is kinda tiny but I got it done.

By Richard Feloni July 11, 2014

It can be easy to get caught up in the routine of life, doing whatever it takes to get from one point to the next, without doing much that’s exciting or enriching.

Some Quora users offer a few ideas to break the routine in their responses to the thread: “What is something every person should experience at least once in a lifetime?”

The responses range from trying an extreme sport to discovering something life-changing about yourself. We’ve summarized some of the best answers below.

1. Live somewhere vastly different from your hometown.
Living in an unfamiliar setting among people with a different worldview from yours can help you become more self-reliant. —Deepthi Amarasuriya

2. Go out of your way to help a stranger.
Put in time and effort to help someone you have “absolutely no social, moral, or legal obligation to help,” and don’t expect anything in return. —Kent Fung

3. Learn how to appreciate being alone.
Avoid feeling lonely on your own by truly becoming comfortable with yourself. —Barbara Rose

4. Travel without being a tourist.
Go on a trip without feeling the need to take nonstop photos of the biggest tourist attractions. Instead of being a “tourist,” be a “traveler” and try to get an idea of how the locals live. —Arya Raje

5. Take a trip without making any plans.
A “serendipitous adventure” free of the restrictions of an itinerary can be both thrilling and relaxing. —Julian Keith Loren

6. Go paragliding/parasailing/skydiving — anything where you’re flying through the air. The feeling of weightlessness you get is a joy unmatched by anything else in life. —Sainyam Kapoor

7. Learn how to get by on the bare minimum.
If you’re just starting out professionally and fortunate enough to not know a life of poverty, it is worth struggling to make it on your own without the safety net of your family. You’ll learn to appreciate what you earn. —Anonymous

8. Work a service job.
If you’ve never had a difficult job like being a waiter, courier, or janitor, then try volunteering somewhere like a shelter. You’ll learn patience, humbleness, and dependability. —Diego Noriega Mendoza

9. Become comfortable speaking in public.
Public speaking is consistently ranked among people’s top fears, but developing the skill can advance your career and boost your confidence. —Mark Savchuk

10. Participate in an endurance trial like a marathon.
Athletic events like marathons and long cycling races are essentially “voluntary suffering” that can teach you that with enough determination, you can get through anything and appreciate the journey. —Denis Oakley

11. Go scuba diving.
“It is like exploring a completely new world.” —Rajneesh Mitharwal

12. Learn to dance.
Most people are embarrassed to dance at events without the help of some alcohol, but instead of making a fool of yourself at every wedding, learn some real techniques! —Meenakshhi Mishra

13. Run or volunteer for some position of leadership.
You don’t necessarily need to quit your day job and start a senatorial campaign, but you can take a risk and put yourself out there, even if it’s just to become head of your company’s intramural softball team. —Warren Myers

14. Learn to appreciate failure.
Life is filled with defeats and setbacks. You can choose to suffer through each of them until your fortune improves, or you can learn to appreciate the opportunities for learning every failure provides. “It will help you to know yourself — what motivates you, what you did wrong, what makes you happy, and so on.” —Shikhar Argawal

15. Witness the birth of a child.
Seeing the birth of another human being, especially your own child, of course, is something you’ll never forget. —Jack Martin

16. Develop a bond with an animal.
Anyone who has a pet can tell you that the unconditional love you receive from an animal you care for is powerful and increases your overall happiness. —Simon Brown

17. Ride an elephant.
“There’s something incredible about being on top of a majestic animal.” —Ridwa Mousa

18. Drive as fast as you can down an empty road.
Don’t drive recklessly, of course. But if you’re a good enough driver and get a chance to drive down the speed-limit-free German Autobahn, go for it. —Cyndi Perlman Fink

19. Become as good as you can at one sport.
If you make a lifelong hobby of practicing your favorite sport, you will make leading a healthier life fun, challenging, and goal-driven. —Shiva Suri

20. Take a sabbatical from work.
At least once, step away from your professional life to pursue a passion or travel extensively. —Asmita Singh

21. Meditate in a redwood forest.
The massive, ancient trees in California’s redwood forests give you a chance to reflect in untouched nature. “It’s a spiritual and cleansing experience.” —Krystle Smart

22. Fly down a mountain on skis or a snowboard.
Entering a state of extreme focus as you soar down a snowy path can be a euphoric experience. —Pete Ashly

23. Camp in the wilderness hundreds of miles from civilization.
Experiencing what it’s like to live without the luxuries of society will make you appreciate the beauty of nature as well as everything that makes your life easier. —Justin Jessup

24. Perform on stage.
“No matter how stage shy you are and if you don’t know how to sing or dance or act, just get on that stage once. Do your thing and own it. After this, I guarantee you will feel like a whole new person.” —Pritika Gulliani Jain

25. Swim in the “Devil’s Pool” above Victoria Falls in Zambia.
And if you’re a big risk-taker, at certain times of the year you can wade in a slow-moving pool that forms at the lip of the world’s largest waterfall. —Liz Dugas

What is an ILIT? Why Doctors and Business Owners Should Consider Having One

scales of justiceMy Comments: A disclaimer here: I’m not an attorney. But Ike Devji is and I’ve followed him for some time and his writings are relevant and make sense.

I’ve recently been involved in some discussions with physicians and business owners about life insurance. Their questions and criticisms almost universally reflect an ignorance about the topic and frustration that my answers are always preceded by more questions. And then given with caveats and qualifications.

That may be because I’m somewhat cautious in this age of litigation. Or it may be because I’ve seen so many situations go awry that making a truly informed decision, even though it takes longer, simply avoids a lot a pain and heartache most of the time. But Ike’s comments are good ones, so please, pay attention.

Ike Devji on July 1, 2014

We’ve previously devoted a number of discussions to the use of life insurance by physicians and business owners, including a look at how to buy insurance, discussions of its specific uses and how much life insurance a doctor and his or her spouse should have. In this article we take an introductory look at a legal structure that often accompanies life insurance in an estate plan, the irrevocable life insurance trust (ILIT).

What is an ILIT?

It is an irrevocable trust that, for the purposes of our introductory discussion, cannot be changed or amended outside a few very specific exceptions. It is a formal legal structure that should be drafted by a qualified attorney familiar with both estate and gift tax laws. It is specially created to hold life insurance policies, as well as cash and various other valuable assets that may be used to fund policy premiums or managed for other benefit of the named “beneficiaries” — the parties for whom the trust was set up.

The policy may be either purchased by the ILIT outright or later sold or gifted to the trust by the person creating the trust, known as the “grantor.” Finally, the grantor appoints a trust manager who can make discretionary distributions and who helps manage the trust known as a “trustee.” The trustee cannot also be a grantor and, despite the common practice by many estate planners, in my opinion, should not be a beneficiary. In other words, it should be a third party.

What does an ILIT do?

In the majority of cases it’s used for a basic estate-planning reason — to put the proceeds of a large life insurance policy outside the taxable estate of the grantor. This means that the death benefit can be used to either supplement the value of the estate or to help pay any estate taxes that might be due by purchasing illiquid assets that might otherwise have to be sold to pay the taxes, as just one of several examples.

Why can’t a grantor also be a trustee?

We avoid this practice for the reason that is at the core of this column, asset protection, as we do not want a beneficiary who has the power to make discretionary distributions of trust assets to be forced to make a distribution to his or her own creditors. The ILIT provides creditor and principal protection of the assets in the trust (including any death benefit received upon the death of the insured) in several ways:

1. It protects the assets in the trust from estate tax by excluding them from the grantor’s taxable estate.

2. It can protect the cash value and death benefit of a life insurance policy from creditors. Some states protect cash values to a very high, even unlimited, dollar amount, while others do not; a properly drafted trust easily achieves this result.

3. It protects the death benefit and other trust assets from the creditors of the beneficiaries themselves, including future spouses. So, if the beneficiaries of your estate face a future lawsuit, bankruptcy or divorce, this asset will be protected from those exposures or even from the beneficiary themselves if they are minors or have other significant exposures like mental or physical disabilities, addiction problems, or other behavioral issues.

4. It protects present assets intended to go to the beneficiaries, including plain old cash you may intend to fund the policy with now or in the future, from the grantor’s creditors. Said simply, it allows the irrevocable present transfer of assets into a “safe” that the trustee can use to pay for the insurance premiums in the future.

This is a very general introduction to a tool that can be exceptionally complex and is not a recommendation that every doctor or business owner out there needs or is even qualified for an ILIT. As always, a good tool is only “good” if it is a fit for your very subjective goals and needs. We will continue our discussion of this topic in the near future, including a look at how assets in an ILIT can be protected from your creditors and still accessible to you during your lifetime through the use of loans.

(Note: Mr. Devji lives, I think, in the state of Washington. If you want someone local to help you with this, call or email me and I will have local names for you that are excellent attorneys – TK)